Toolbox: Avoiding pitfalls in SMSF compliance

The results of the recently releasedAustralian Taxation Office(ATO) self-managed superannuation funds (SMSF) Compliance Review benchmarking study provide more certainty and clarity on the ATO’s compliance approach and its view on the current operation of SMSFs in Australia.

The results of the benchmark study reinforce the ATO’s move towards rebalancing its compliance program to that of a mix of education and enforcement.

More emphasis will be placed by the ATO on compliance issues relating to the Superannuation Industry Supervision (SIS) Act, as this was identified as the area where most compliance difficulties arose.

In releasing the study, ATO deputy commissioner, superannuation, Mark Jackson said advisers should always revert to the sole purpose test as the most fundamental rule of the SMSF environment. One of the supporting rules that also received a mention was the need for financial dealings between an SMSF and its members or related parties to be conducted on an arm’s length basis.

One of the results of the benchmarking assessment was many SMSFs were lacking some of the basic elements of a complying SMSF, such as an investment strategy, or lack of records of meetings where decisions were made to revise the fund’s investment strategy. The ATO has indicated that attention will be placed on such behaviour and will attract the sanctions and penalties at their disposal.

The area where most non-compliance was found to have occurred was the failure to keep SMSF assets separate from the trustee(s) business. In some cases, assets were held in one of the trustee’s name rather than the fund name, which increases the risk associated with the asset.

A related issue is that of employer/member responsibilities relating to fund expenses.

A paper will be released on this issue in a few months. This issue has been identified in an ATO draft circular and advisers should take note when reviewing their clients’ SMSF operating procedures.

The deputy commissioner also commented and expressed concern in relation to the ATO’s view of certain SMSF investment restrictions:

Business real property

* Although the trustees are allowed by law to invest 100 per cent of the SMSF’s assets in business real property, it is questionable whether that represents a prudent investment strategy to have all of the fund’s assets in one basket. (Advisers may be able to assist in providing other investment avenues that are within the fund’s investment strategy.)

* Residential property rarely fits the ‘business real property’ definition.

Collectibles and art

* An updated fact sheet on the ATO web site entitledInvestment Strategy and Investment Restrictions,outlines the ATO’s view of appropriate and inappropriate investments.

* There are no restrictions on SMSFs investing in collectibles and art, but under the sole purpose test, members cannot enjoy the benefit from the investment prior to preservation age, and a trustee can only display art in their home or office under very strict conditions.

* The leasing of artwork or other collectible to a member or related party is allowed as long as the in-house asset rule is met. That is, the investments must not exceed 5 per cent of the funds’ total assets and must satisfy the arm’s-length rule of being leased to the related party at commercial rates.

Residential property

* Leasing of residential property to related parties where the value exceeds 5 per cent of the fund total value breaches the in-house asset rules.

* Generous terms attached to leasing arrangements suggest that arm’s-length rules were being ignored.

* Situations of overdrawn fund bank accounts, the fund not having a bank account or all fund banking conducted via the trustee’s personal account are deemed unacceptable trustee behaviour by the ATO.

Auditor’s role and responsibilities

* Jackson says: “We have real concerns about the notion of independence where an auditor is also involved in the day to day running of an SMSF, is in a position to influence the fund’s decision-making processes, including the provision of financial or investment advice, or has responsibility for maintaining the accounts and preparing the fund’s financial reports.”

* As part of the compliance program, the ATO will be reviewing 250 funds to gauge the proficiency of fund auditors and another 2,600 identified by their auditors as having compliance problems.

Problems relating to trustees’ understanding of SIS and tax legislation were also identified in the recent benchmarking assessment. A second benchmark assessment is underway in which results will be compared and areas of concern identified.

Kevin Smith is head of technical services atBT Financial Group .