SMSF reform: going to excess

Continuous tinkering with the rules relating to self-managed super funds (SMSFs) and superannuation in general is causing serious concerns for advisers and inflicting draconian penalties on investors, writes Caroline Munro.

Self-managed superannuation fund (SMSF) advisers are faced with a number of concerning issues, but the excess contributions tax (ECT) has been causing the worst headaches for a couple of years now.

The issue has become more prominent in the media in recent months, as the number of breaches has dramatically jumped since the lowering of the contributions caps and the 46.5 per cent tax penalty has become more commonplace. While the ECT potentially affects all super members as well as SMSF trustees, it has been argued that SMSFs are more at risk because trustees and members are more engaged with their super and are more likely to take advantage of opportunities to boost their retirement savings through contributing.

National technical director of the Self-Managed Super Funds Professionals’ Association of Australia (SPAA), Peter Burgess, says the ECT is the most significant issue faced by the super and SMSF sector, exacerbated by the halving last year of the contributions caps. He says the SPAA believes that not only are the contributions caps too low, but the complexity of the contributions rules are leading to many people inadvertently breaching the caps and incurring significant ECT bills. Burgess adds that the severity of the tax penalties do not fit the crime.

Cavendish Superannuation SMSF specialist executive David Busoli thinks that the ECT penalties are targeting the wrong people, and describes the penalty regime and its implementation as “appalling”. Busoli says the Treasury is trying to diminish the significance of the issue when in fact the strict ECT penalties are affecting members and trustees across the superannuation and SMSF sector.

“And for those that are hit, many of them are hit unbelievably hard for what is a relatively minor transgression,” he says.

BT Financial Group senior manager of technical consulting, Bryan Ashenden, says the number of excess contributions notices sent out by the Australian Taxation Office (ATO) in the 2009-2010 financial year was 65,733 – up from 28,291 in the previous financial year. However, Ashenden says it is interesting to note that the average amount by which people had breached their caps had actually fallen.

“The quantum of each breach is about 40-45 per cent lower,” he says, assuming that the reason may be because the breaches are more likely inadvertent or beyond the trustee or super member’s control. He suggests that it may simply come down to timing issues whereby the employers may contribute at different times in the year, perhaps triggering a breach by making two contributions in one financial year.

Burgess says the sheer number of breaches is concerning, and yet the ATO is very limited in its ability to show discretion. While there are no available statistics to quantify how much people have actually been taxed as a result of ECT, he says a conservative guess would be about $20 million.

“It’s just the sheer number of assessments that we’re seeing,” he says. “And in most cases we’re not talking about a few dollars – the amount of tax concern runs into thousands of dollars.”

Aside from the loss of retirement savings through the ECT, the lowered contributions caps alone have resulted in an incredible loss of money to the SMSF sector, according to the Russell Investments/SPAA inaugural annual SMSF study, conducted by CoreData/brandmanagement. The survey found that the lowered concessional contributions caps have resulted in a loss of $15.1 billion, as around half of SMSF trustees surveyed stated they would have contributed on average $72,704 each to their SMSF if the contributions caps were raised.

Lack of discretion

Burgess says although those that inadvertently breach their caps have the avenue to apply to the ATO for discretion, in the majority of cases the ATO is not able to do so. Tax Commissioner Michael D’Ascenzo, speaking at SPAA’s recent annual conference, admitted that the gap for the ATO showing discretion was very narrow. He said the ATO’s hands were tied and it was now an issue for Treasury.

Ashenden says as a general rule the ATO will show discretion if the excess contribution results in something that the super member or trustee does not have any control over. However, Busoli felt that the ATO actually did so in a very small number of cases.

In certain cases where it was obvious the contributions breaches were beyond the trustee or super member’s control, the ATO was adamant that it would not show discretion, says Busoli. One of the examples he gives is that of a doctor who works for three hospitals and gets $100,000 from each employer and a superannuation guarantee contribution of $9,000 from each hospital. In this case, the employer contributions would be $2,000 over the current cap. Busoli explains that neither the doctor nor the hospitals can contract out of that agreement, and yet the ATO made it clear they would not be able to exercise discretion in this instance.

“Pretty much the only situation where I’ve seen the ATO exercise discretion is where you have an account being rolled over from the UK, which is subject to the non-concessional caps and there has been a currency fluctuation in the process,” he says.

D’Ascenzo noted at the SPAA conference that only 8 per cent of trustees who had breached the caps and received an assessment notice had applied to the commissioner for discretion. Ashenden says it may be because when people got a tax bill they simply paid it because they thought they had no choice and did not realise they could apply for discretion.

“A large part of it is because people aren’t advised,” he says.

However, Busoli believes that the low numbers are a result of the general realisation that most applications would be unsuccessful.

Macquarie Adviser Services technical manager and SPAA director, David Shirlow, says the small number of applications for discretion is surprising considering that a high number of breaches were due to incorrect reporting.

“You would expect that in those sorts of cases people would be applying, because it’s not so much a matter of applying for discretion as making sure that the records are corrected,” he says.

He adds that although the ATO’s ability to show discretion is very limited, some cases where it has been able to do so have been surprising and he urged people to take a chance and apply anyway.

Shirlow and Burgess say that the number of excess contributions assessments issued by the ATO is likely to increase in coming years, especially given that the 2012-2013 financial year will involve a halving of the caps for people aged 50 or more, and for others aged 50 or more there will be a $500,000 threshold.

“That in itself is extremely complicated,” says Shirlow. “It will really increase the number of circumstances where people get it wrong.”

Lobbying for change

The SPAA – along with other organisations like the Tax Institute and the National Institute of Accountants – has been active in not only lobbying the Government to increase the contributions caps but to introduce a fair solution to the ECT issue. Burgess says the limited cases in which the ATO can show discretion point to the need for legislative change. The SPAA has put forward submissions to Treasury suggesting a refunding solution that will allow clients, as soon as they’ve realised they’ve gone over the cap, to go to their fund and ask for a refund of the excess, he says.

“We’re not suggesting that they get off scot-free – we are suggesting that there will be an interest or penalty rate charged on that excess for the period that it was in the fund. But that penalty rate would be significantly less than what we’ve currently got, which is the 46.5 per cent tax rate,” Burgess explains.

He says the suggested penalty would be much more suited to the crime and the penalty would be sufficiently high to deter people from deliberately exceeding the cap. Burgess says there is no way of knowing whether the SPAA’s refunding suggestion is palatable to Government, because the SPAA has not yet received a response from Treasury.

Busoli is pleased that the industry is finally getting traction in the media on an issue that has been of concern for the last couple of years.

“Now it is getting some attention and it is time for the politicians, who are no longer in election mode and are getting down to work, to listen to this,” he says.

“The Government is always talking about how it wants to increase the savings of retirees, yet they are hitting them with this horrendous tax over relatively small situations. This is a straight tax grab and this hasn’t received the right attention because there have been so many other things that the Government has been focused on – it deserves their attention and furthermore it should be looked at retrospectively.”

Client understanding of the issue

Fund managers and super providers have attempted to help advisers deal with this issue by developing super contributions trackers and other simple tools to help them compile all the available information needed from clients. But what they can provide in terms of trackers is limited to individual funds, and in most cases the adviser is reliant on the information provided by their clients.

Busoli says things like super trackers are essential, even if they only track contributions to a single fund. However, it is also a matter of bringing a client’s thinking in line with the severe reality of the situation, he asserts. Clients may be under the misapprehension that small breaches of a few dollars are insignificant, says Busoli.

“If you were a client, how could you think that a $10 mistake could incur a $140,000 tax bill?” he says. “You wouldn’t think that was reasonable and you wouldn’t give it any credence.”

Busoli says communication becomes even more difficult between advisers and clients when clients do not realise that certain things even constitute contributions, such as paying an expense of the fund or improving an asset that the fund owns.

The Russell survey revealed a knowledge gap in terms of what SMSF trustees could and could not do, and yet 90 per cent of trustees rated their own knowledge highly, according to Russell Investments managing director for retail, Patricia Curtin.

“We do have a segment that is very well educated, but there is a knowledge gap in terms of regulatory change,” she says. “Some of the mismatch relates to what are their greatest challenges – advisers see that compliance and adhering to regulatory change are the greatest challenges, whereas trustees would see sourcing good advice as their greatest challenge.”

Considering 42 per cent of respondents were unsure of their investment goals, “we need to ensure that there is more science and less art in SMSFs”, she says.

Professional indemnity claims

Relationship building and communication between clients and advisers is therefore essential. But even then, as Ashenden points out, excess contributions may just be a result of timing issues with employers’ contributions and it may be a good idea for advisers to recommend leaving a buffer if there is some uncertainty.

“If you leave a buffer you reduce the possibility of the client breaching their caps, but they also lose out on opportunity,” he says. “That’s really a cost/benefit analysis, and it is something that advisers should discuss with their clients.”

Burgess acknowledged that individuals are increasingly leaving a buffer, but this practice is problematic.

“What we are seeing at the moment is that individuals, practitioners as well as clients, are so nervous about breaching the caps and the severity of the penalty that applies that they are deliberately underfunding and staying well below the cap,” he says. “That is a problem because we’ve got people who are underfunding, and the caps are low enough as they are.”

Burgess suggests that advisers take the time to make sure they are aware of the contributions their clients have made in the current financial year as well as the two previous years, going even further back should there be concerns about the bring forward rules.

The whole point of making contributions is to maximise savings, and some have questioned whether leaving a buffer exposed advisers to the risk of claims if the buffer were ultimately unnecessary. Ashenden says there should be no grounds for claims as long as leaving a buffer was discussed properly between an adviser and client, and agreed upon by the client.

In any case, excess contributions have resulted in claims and are an issue that the professional indemnity insurers are paying more attention to, says Busoli.

“The professional indemnity insurers will be looking at this one very carefully, because they weren’t expecting this – they’re used to dealing with product type claims,” he says.

Busoli adds that this different type of claim was unexpected and significant from a professional indemnity insurer’s perspective.

“Some of the claims are huge,” he says, referring to a recent case where a client incurred a $130,000 tax bill because of a $300 error.

“And that’s the sort of thing that people are being hit with – I find it extraordinary,” says Busoli.

Burgess agrees that there has been an increase of claims regarding excess contributions and he knows of instances where advisers have compensated the client. He says it is therefore critical that advisers find out as much as they can about what contributions have been made, adding that advisers should not rely on the information from the ATO. ATO records are not always up-to-date due to delays between the time funds have to lodge their contributions information to the ATO, and when the ATO records it, he explains.

“The adviser either has to seek that information from the client’s fund or they have to re-create and keep those records themselves for their clients,” says Burgess.

Confidence in SMSFs

Curtin says advisers are mostly optimistic about the future demand for advice around SMSFs and expected demand to increase – 35 per cent of advisers in the Russell survey felt that demand would increase dramatically. However, she says, there are several concerns that advisers have around excess contributions as well as the rules around borrowing within super.

Tinkering with super by the Government has impacted investor confidence in the retirement savings system, says Burgess.

“We know consumers don’t like to see further tinkering of the rules, because it takes away from their confidence in the system,” he says.

The Russell research revealed that three in four SMSF trustees were confident in the superannuation system as a vehicle for retirement savings. However, advisers and trustees were equally fearful of legislative change and the prospect of Government tinkering with super – advisers were concerned about compliance obligations and regulatory change, while trustee apprehension was leading them to hold assets outside of super.

Curtin says that some of the regulatory change may stifle growth and impact on consumer trust.

“To ensure that we provide for adequacy in retirement, we do need to ensure that we keep canvassing – from the regulatory point of view – to ensure that people save within the superannuation environment, rather than looking to save outside,” she says.