Opinion piece written by John Maroney, CEO, SMSF Association
The sector is anxiously waiting to see if the Labor government will proceed with some crucial changes that were in the pipeline before the election.
The self-managed super fund (SMSF) sector is anxiously waiting to see if the Labor government will proceed with three reforms that were in the pipeline before the May 21 election.
The government will now have to decide whether to sign off on reforming the residency rules for SMSFs; establishing an amnesty period to allow SMSF members with legacy pensions to convert to more conventional style pension products; and reviewing the non-arm’s length expense (NALE) provisions.
All three are deemed critical for the sector.
Reforming the residency rules for SMSFs has been on the super sector’s wish list for more than a decade.
Australians who are temporary residents overseas for more than two years can’t contribute to their SMSF because it fails to meet the definition of an Australian superannuation fund. It is therefore treated as a non-complying fund, invoking penalties and the potential to be taxed at 45 per cent.
The alternative for trustees to make contributions to an APRA-regulated super fund and rolling those contributions back into their SMSF on return to Australia is hardly appealing.
Aside from being cumbersome and being forced to contribute to a fund that’s not their preference, it causes significant additional costs.
So, the existing two-year safe harbour exemption test was increased to five years in the 2021 federal budget. That was an important reform for many expatriate Australians working overseas, but is yet to be formalised in legislation.
Suggestions that extending the period Australians living overseas can contribute to their SMSF will impinge on the integrity of the superannuation system are unfounded.
Control and management tests
The establishment and central control and management tests in place ensure that only Australian-based super funds can benefit from the tax concessions.
The call to grant an amnesty period to convert legacy pensions to account-based pensions benefits the government, regulators and industry because of modernisation, simplicity and efficiency.
Despite not being an extremely large segment of the sector, the administrative burden and amount of adviser, ATO and Treasury time and resources allocated to the issue of legacy pensions is significant.
Since January 1, 2006, SMSFs are no longer allowed to start lifetime and life expectancy complying pensions. However, if the pension started before this date, it could continue operating.
The “non-commutable” nature of these pensions meant they received concessional treatment under the now repealed reasonable benefit limit regime. These pensions also receive concessional asset test treatment when assessing eligibility for certain government income support payments.
Today, legacy pensions exist in an environment where they have little relevance and where many SMSF trustees do not fully comprehend their operation and the impact on their transfer balance caps (TBC). In addition, they are difficult to administer, explain and advise on.
Significant regulatory changes to superannuation laws have further diminished their relevance in the industry. The introduction of the TBC has resulted in some of the most complex laws and outcomes in financial services for these pensions. There are many legacy pensions where the costs of administering them is substantial, given the relatively low balances.
The NALE provisions, which took effect on July 1, 2018, go much further than originally intended, not only for SMSFs but APRA-regulated funds. For example, there are situations where all the income received by an SMSF, including taxable contributions and realised capital gains, could be taxed at 45 per cent because the SMSF failed to incur a small fund expense on arm’s length terms.
Another example is where all the income an SMSF receives from a particular investment, including any realised capital gains on selling an investment, could be forever tainted as a NALE because of a simple oversight.
The ATO has stated that if it is a general expense that is not on arm’s length terms, and it relates to a service that has not been provided by an individual in their capacity as trustee, they will not apply any compliance resources that could cause the fund’s income to be taxed at 45 per cent.
Thankfully this concession, which was due to expire on June 30 this year, has been extended for another 12 months.
However, it’s important to remember this concessional compliance approach only applies to expenses that are general in nature. It doesn’t apply where the expense that has not been incurred on arm’s length terms relates directly to a particular fund investment.
For example, if an SMSF owns a property and it is renovated or repaired by a related entity who does not charge an arm’s length expense, the rental income received by the fund from the property – as well as any realised capital gains received when the property is eventually sold – could be taxed at 45 per cent.
Scenarios such as this illustrate the punitive nature of these provisions and explain why the industry was so relieved when the previous government announced it would amend the rules to ensure the NALE provisions operate as intended.
It’s also why the industry is anxiously waiting to see if the Labor government will make the same commitment.