Advice at the fringes of financial services

In April the Federal Government released a draft to industry of its bill changing the investment standards for superannuation funds (seeMoney ManagementMay 13). This bill amends the investment rules for all superannuation funds, but has most effect on self managed super funds (SMSFs). The Government has now introduced this bill to parliament asSuperannuation Legislation (Amendment) Bill 1999 No. 4(SLAB 4).

New rules

SLAB 4 introduces new investment rules that expand the definition of what constitutes an in-house asset of a superannuation fund. All investments, loans and leases made to related parties will now be considered in-house assets, unless they fall within one of the limited number of exclusions.

In this context, a related party is either an employer sponsor and their associates or a member of the super fund and their associates. Associates include relatives (widely defined), partners and companies or trusts that are controlled by the member or employer sponsor.

SLAB 4 also extends the ban on super fund asset acquisitions from members to include acquisition of assets from related parties.

A super fund cannot invest in new in-house assets if they exceed 5 per cent of the market value of the fund when added to the fund's total assets. If the fund exceeds 5 per cent, it risks a fine up to $1m and the prospect of becoming non-complying in certain circumstances - with all the associated penalties.

DIY concessions

The SLAB 4 concessions to self managed super funds allow them to both invest up to 100 per cent in business real property (specifically defined) and lease that to a related party as well as acquire business real property from a related party.

SLAB 4 transitional rules for existing arrangements include:

Investments, loans and leases already in place (or a contractual obligation already in place to enter into an investment, loan or lease) as at 12 May 1998 can continue;

Investments, loans and leases made between 12 May 1998 and the date the Bill receives Royal Assent* will not be treated as in-house assets until 1 July 2001.

Investments, loans and leases made after the Bill receives Royal Asset will immediately be treated as in-house assets (ie they cannot exceed 5% of the market value of the fund when added to the value of existing assets).

The bill vs the draft

There are four main differences between the bill presented to parliament and the previous draft bill:

The transitional rules in the draft bill referred to investments made between 12 May 1998 and the date of introduction of the bill into Parliament. These transitional rules now use date of royal assent (approved by parliament and signed by the Governor-General).

If an investment in a related company or trust was in place as at 12 May 1998, the date for reinvestment of distributions has been extended to 30 June 2009 from the draft date of 30 June 2005.

Similarly, additional investments in partly paid units or shares (originally in place as at 12 May 1998) by a super fund won't be counted as in-house assets if they occur prior to 1 July 2009, provided these extra investments are simply making the units or shares fully paid up.

There is also a new proposal in the bill that deals with a self managed super fund with an investment in a related entity as at 12 May 1998 and that related entity has geared itself (see break-out story).

BREAK-OUT 1

What the new gearing rule means

A new concession allows a super fund with fewer than five members to make extra investments in, or loans to, a related unit trust or company that had a loan from a third party in place at 12 May 1998.

This concession was introduced after industry expressed concerns that many geared unit trusts held by self managed funds would have to sell their properties to pay back their loans. This was because the original proposals would have classed as in-house assets any extra investments a super fund made in its geared unit trust to help the trust pay back its loans.

Under this concession, extra investments in, or loans to, the related trust or company won't be counted as in-house assets provided:

the amount is limited to the debt the trust or company owed to other parties (not the super fund) at 7.30pm on 12 May 1998 (pro-rating applies if the limit is exceeded - the concession is not lost);

the investment or loan occurs before 1 July 2009;

the super fund has fewer than five members;

the fund elects to have this concession within 12 months of SLAB 4 receiving royal assent.

Importantly, by making this election a self managed fund rules itself out of three other key concessions it would otherwise receive:

the reinvestment concession in 2 above;

the "partly paid" concession in 3 above;

another concession applying to investment and loans made to binding contracts entered into before 12 May 1998.

Caught in the web: a case study

This case study assumes the bill is passed unamended by December 1999. A self managed super fund, which has assets of $200,000, purchases a $100,000 beach house before 12 May 1998. The fund rents the house to third parties and receives an income. This year the fund rents the house to one of its members at market rate for two weeks at Christmas.

This two week breach is enough to affect the fund's compliance for the whole year. The lease to the member (assuming it was arranged post-royal assent) will be an in-house asset despite the fact that the beach house itself was purchased prior to May 1998. In addition the value of this in-house asset is taken to be the total $100,000 value of the beach house, taking the in-house asset level well beyond the permitted 5 per cent.

Nick Ingram is at Westpac Financial Services.