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.

Consultation Paper on Refund of Excess Contributions Tax released

You will have the ability to accept or decline the Commissioner's Notice of Offer to refund the Excess Contributions Tax

The 2011 Federal Budget provided some relief on the issue of Excess Contributions Tax (ECT), with the announcement of a ‘one time only’ refund of excess concessional contributions up to $10,000. We have now seen the release by Treasury of the consultation paper regarding the Refund of Excess Concessional Contributions.

The consultation paper discusses a range of issues around the impacts for the individual, super fund and employers, including eligibility for the refund, choosing to accept the refund offer, and the acceptance process.

To understand the mechanics outlined in the consultation paper, let’s consider the following example:

Example – Refund of Excess Contributions Tax

Toby (47) currently earns $100,000 year and salary sacrifices into his SMSF. For the 2011/12 financial year, he has made concessional contributions totaling $32,000. Upon lodgement of his 2012 individual tax return and the SMSF Annual Return, the ATO determines that he has exceeded his concessional contribution cap by $7,000 (CC cap of $25,000 – under 50). As the excess concessional contributions:

  • have been made in the 2011/12 financial year or later;
  • are $10,000 or less; and
  • are the first time Toby has breached the concessional contribution cap (in a financial year being 2011/12 or a later year);

the Commissioner will provide Toby with a “Notice of Offer” to have the excess concessional contributions released from his SMSF and assessed personally at his marginal tax rate. The difference in this example being 46.5% ECT vs. 38.5% personally. Toby has 28 days to choose whether to accept the offer or not (in full).

Where Toby accepts the offer, the excess concessional contributions will become assessable to him personally (i.e. ATO will amend Toby’s 2012 individual income tax assessment). As the SMSF will have already paid the 15% contributions tax via the 2012 SMSF Annual Return, the Commissioner will provide the Fund will a compulsory release authority for 85% ($5,950) of the excess concessional contributions. The SMSF must pay the relevant amount within 30 days of receiving the release authority, along with a release authority statement (these time-frames replicate the current non-concessional ECT compulsory release requirements).

With the ATO now holding the excess contribution amounts, the Commissioner will amend Toby’s 2012 tax assessment to include the concessional contributions as assessable income. This amends Toby’s tax position to how it would have existed if the excess concessional contributions were not made.

The income tax and medicare levy payable (and flood levy if exceeded in 2011/12) will be reduced by a refundable tax offset equal to 15% of the excess concessional contributions. This effectively recognises the contributions tax already paid on the excess concessional contributions (and that no double taxation applies).

The Commissioner will then apply the released amount from Toby’s SMSF to his outstanding tax liability as a result of the amended assessment. The remainder of the money will be then refunded to Toby (or applied to other debts he may have with the ATO or Commonwealth). Toby will receive a notice of amended assessment with the refund cheque.

The refunded excess concessional contribution will not count towards his non-concessional contribution cap.

I’ve outlined a few important points to note from the consultation paper:

  • the $10,000 excess contributions tax refund limit will not be indexed;
  • If an individual lodges their personal income tax return late (beyond one year after the ITR was due), they forfeit their right to have an offer to release excess concessional contributions;
  • Where an individual breaches the concessional contribution cap by more than $10,000, there is no refund option available, plus they also lose their ‘once-off’ eligibility as a result of the ECT amount;
  • It is a ‘all or nothing’ approach – there is no ability to request a partial refund of the excess concessional contributions;
  • If a personal has multiple super interests, the regulations will outline which interest the compulsory release authority is to be deducted from; and
  • Where there is insufficient capital in the Fund to pay the compulsory release amount, the amount will be personally assessed to the individual and a tax liability raised.

Careful consideration needs to be given not only to the tax consequences of accepting the offer from the ATO, but the potential flow-on impact of the amended assessment. The amended assessable income of the individual may impact Government benefits including Family Tax Benefit, Child Care Benefit, Centrelink and other child support agency requirements. In addition, it could change the qualification for co-contribution amounts and other tax offsets.

Submissions are open until 7 September 2011. Further information can be found on the Treasury website.

Draft Regulations to streamline deductions for TPD insurance in super

Last week has seen the release by Treasury of draft regulations to streamline the process for claiming tax deductions on the cost of Total and Permanent Disability (TPD) premiums through superannuation.  Specifically, this legislation to be introduced as new Subdivision 295-G into the Income Tax Assessment Regulations 1997 (s.295.465.01) provides for percentage amounts of certain TPD insurance premiums (including self‑insurance) that is deductible to super funds.

The table below outlines the type of policy and level of Fund tax deduction available for disability insurance:

Insurance Policy Specified Proportion (%)
TPD any occupation 100
TPD any occupation with one or more of the following inclusions:

  • activities of daily living;
  • cognitive loss;
  • loss of limb
TPD own occupation 67
TPD own occupation with one or more of the following inclusions:

  • activities of daily living;
  • cognitive loss;
  • loss of limb
TPD own occupation bundled with death (life) cover 80
TPD own occupation bundled with death (life) cover with one or more of the following inclusions:

  • activities of daily living;
  • cognitive loss;
  • loss of limb

The impact of these changes essentially means that TPD insurance for “any occupation” is 100% tax-deductible, but TPD insurance for “own occupation” is not.

These changes assist to make things administratively helpful for accountants and administrators in the preparation of the annual statutory accounts, however it becomes critically important to understand the details of the policy type to ensure the appropriate tax deduction is claimed.

Further details regarding the explanatory memorandum and draft legislation can be found on the Treasury website.

State of play with SMSF Limited Recourse Borrowing Arrangements

Which direction will Treasury and the ATO head with Limited Recourse Borrowing Arrangements?

The use of Limited Recourse Borrowing within Self Managed Super Funds continues to capture the attention of trustees and advisers alike.

We are seeing some significant work being undertaken in this area of borrowing to provide greater clarity of section 67A & 67B introduced into the Superannuation Industry (Supervision) Act 1993 (“SIS Act”).

With this activity, I thought it appropriate to post an article outlining the current “state of play” in regards to SMSF Limited Recourse Borrowing Arrangements.  So where are we currently at with many of the ‘grey’ issues?

  • Definition of “Single acquirable asset” – the current ATO view of single acquirable asset for real property is based on its boundaries defined by legal title.  Therefore, the single acquirable asset definition is very restrictive as it does not allow for properties held over multiple titles including farmland and some commercial property.  A more common issue caught by this definition is the car-park attached to an apartment or office building that sits on separate title.  Where assets are inseparable, or where there is an ancillary asset of a very small value, the ATO may treat the assets as a single asset for the purposes of section 67A.  Previous information from the ATO has indicated that a car park does not meet this requirement.  It would be prudent to obtain a private ruling from the ATO where such inseparable or ancillary assets exist.
A workshop was conducted late last year by the ATO with selected representatives of the NTLG Super Technical sub committee to address issues impacting limited recourse borrowing arrangements.  The Institute of Chartered Accountants (“ICAA”) included as part of their submission for the ATO to adopt an accounting standards approach to identify what is a single acquirable asset.  The use of accounting standards looks at the “economic substance” of an asset, not simply the boundaries of legal title.  By taking this view it means that the component parts of an investment property are not looked at but instead they are treated as one whole asset.

It is my understanding that the ATO have taken this information on board and raised the issue back to Treasury as a technical priority issue.  Any change will need to balance the original policy intent of the changes in July 2010 with the current ‘logic’ provided by the industry.  As a result we are unlikely to receive any further information on the matter from Government until August or September this year.

Have you registered for the SMSF Limited Recourse Borrowing day?

  • Improvements regardless of source of funds are prohibited – arguably the most common question I get asked is whether the real property acquired can be improved using the super fund’s own money.  Regardless of the source of funds, any capital improvements would be in breach of the replacement asset rules contained within section 67B of the SIS Act.  Therefore if any capital works need to be undertaken on the property, they should be completed prior to purchase, otherwise at this stage we are stuck with only being able to repair an asset to its original state.
  • Repairs vs. Improvements – the already ‘grey’ issue within tax law now also resides within superannuation law with the introduction of section 67A(1)(a)(i) that allows the acquisition of an asset to include expenses incurred in maintaining or repairing the asset to ensure that its functional value is not diminished. The only guidance currently available is contained in Tax Ruling TR 97/23. The ruling applies a very rigid approach in determining what is a repair vs. improvement.

Read further information from my previous blog, are limited recourse borrowings beyond repair?

To understand some of the issues being confronted by the introduction of these changes to superannuation law and the application of TR97/23, let’s look at a few examples:

    • New hot water system — the replacement of a depreciable asset such as a hot water system would not be considered a repair for tax purposes. Accordingly, any new system would be capital and constitute a replacement asset?
    • Painting internal surfaces — if the painting involves a full refurbishment, which results in the interiors being changed, updated, upgraded or otherwise improved (i.e. the new asset is different either in form, quality or functionality than the original), the costs would be on capital account and therefore be in breach of the replacement asset rules.  If the painting merely puts the internal surfaces back to the condition that they were in, e.g. before the surface was damaged, the costs should be deductible as repair costs.
    • Replacing emergency lights — as with the hot water system, the new lights would generally be considered to be the replacement of depreciable assets and therefore not repairs.

I understand that issues regarding improvements to the acquirable asset have been discussed with Treasury as a priority technical issue.  We can only be hopeful that the ATO would not apply this very strict approach to real property owned within a SMSF (otherwise some tenants may be having cold showers!!)

  • Properties affected by natural disaster – with the significant impacts of floods, fires and other natural disasters over the past year, it was pleasing to see the Commissioner state that they would use their discretionary powers for a SMSF to retain its complying fund status (section 42A) to repair damaged properties, even where these repairs would constitute a replacement asset.

Refer to my previous post, replacing assets using limited recourse borrowings affected by natural disasters.

  • In-house assets – the ATO has made clear that in their view there will be a breach of the in-house asset rules if legal title is not transferred to the SMSF after the borrowing has ended.  By retaining the asset within the holding/bare trust, it will be an investment in a related trust.
  • Reviews of ATO Interpretative Decisions (ATOIDs) – expect the ATO to revisit ATOID 2010/162 – borrowing from a related party on more favourable terms to the SMSF.  This initial interpretive decision somewhat caught the industry by surprise with its initial views.  Further thought by the Regulator has suggested that they will go back to the drawing board on this ID to consider the arms-length requirements further and the impact of other areas of superannuation law where the SMSF obtains more favourable terms.  Refer to previous article, What interest rate can you charge your fund for a SMSF limited recourse loan?

These are just some of the mounting issues on the ATO’s plate that are needing to be dealt with on the issue of limited recourse borrowing arrangements.  

With an overlay of the Stronger Super support by the Federal Government to review limited recourse borrowing within two years (30 June 2013), it tempers some of the enthusiasm around for using this strategy within a self-managed super funds.  Hopefully we will see some light at the end of the tunnel shortly providing greater clarification to progress forward with this exciting strategy.

Download the SMSF Limited Recourse Borrowing day brochure to find out more information about the strategies and practical issues of using these highly effective arrangements within a Self-Managed Super Fund.

(C) The SMSF Academy 2012
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