Investment Strategy, Borrowings and Contributions
In this update we will discuss some recent ATO activity, measures being introduced that impact self-managed superannuation funds (SMSFs) and some contribution strategies to consider:
- ATO issues investment strategy warning to SMSFs with property and borrowings
- Super Guarantee opt-out and how it will apply
- Non-arm’s length expenses
- Borrowing arrangements and the impact on Total Super Balance (TSB)
- Downsizer contribution – big take-up with $1 Billion contributed. Are you eligible?
- Carry-forward concessional contributions – can you utilise this measure?
1. ATO issues investment strategy warning to SMSFs with property and borrowings
At the end of August, the ATO sent a letter to approximately 17,700 SMSFs regarding the fund’s investment strategy. This was a targeted campaign by the ATO to SMSFs who held at least 90% of its assets in a single asset class (i.e. property), and also had in place a limited recourse borrowing arrangement (LRBA).
Why did the ATO contact Trustees?
Under the superannuation law, a Trustee of an SMSF must formulate and review regularly an investment strategy that also considers:
- Risk and return on investments;
- Diversification of assets;
- Liquidity of investments and cash flow;
- The ability to discharge liabilities; and
- Insurance considerations and cover for the members.
Specifically, the ATO letter appeared to be targeting the diversification aspect of the above. Recently, the ATO provided a further update on this campaign and stated:
We were concerned that these SMSF trustees may not have given due consideration to diversifying their fund’s investments and the risks associated with a lack of diversification when formulating and reviewing their investment strategy.
They also provided that this lack of diversification together with the borrowing could lead to a significant loss where the sole asset loses value.
What should you do?
Where your SMSF fits the above profile (i.e. has majority of its assets invested in property with an LRBA) or you haven’t reviewed your strategy recently, you should review the investment strategy and ensure it satisfies the above requirements of risk, return, diversity, liquidity, ability to discharge liabilities and insurance. You should also ensure that you have appropriate support and reasons for any fund investments.
2. Super Guarantee opt-out and how it will apply
The Super Guarantee (SG) opt-out was introduced to Parliament in May 2018, where high-income earners who had multiple employers, had the choice to opt-out of receiving mandated employer contributions. This would allow individuals who received contributions from multiple employers and as a result exceeded their concessional contribution cap (currently $25,000), to opt-out of receiving compulsory contributions to remain within the cap and avoid any excess contribution issues. The original legislation lapsed prior to the Federal Election. In July 2019, this measure was re-introduced and is now waiting Royal Assent to become law.
Points to note where you would like to utilise this measure:
- The employee will need to apply to the ATO for an employer shortfall exemption certificate;
- Certificates can be issued to different employers. However, at least one employer must still make SG contributions for the employee;
- The application needs to be made 60 days before the first day of the quarter in which the exemption is to apply;
- The application can be refused by the ATO;
- Just because an individual opts-out to receive SG, the employer is not required to pay the opted-out amount as wages. The employee will need to negotiate this with the employer. This is an important point to note, as employees may be disadvantaged if they apply for the certificate but haven’t arranged with their employer to ensure that the amount not contributed to superannuation is received as salary and wages
3. Non-arm’s length expenses
Non-Arm’s Length Income (NALI) is a concept whereby income derived by an SMSF is taxed at the top marginal rate where the income has arisen from an investment where the parties were not dealing on an arm’s length basis.
This concept has been extended to Non-Arm’s Length Expenses (NALE), where the income, or gain on sale of asset, will be subject to the NALI rules. where expenses incurred by a fund with respect to an asset are not arm’s length.
For example, where an SMSF holds property under a borrowing arrangement and derives arm’s length rent, but does not pay an arm’s length interest rate on the loan, this will be considered NALE and as a result the investment will be tainted with a NALI classification. This would result in the rental income and any future realised capital gain on the sale of the property being subject to NALI and taxed at the top marginal rate, as opposed to tax at 15% in the fund, or 0% (for 100% pension funds).
4. Borrowing arrangements and the impact on Total Super Balance (TSB)
A member’s TSB is generally the total amount they have in superannuation across all of their accounts (however, there are some modifications).
Where a person’s TSB exceeds certain thresholds, they become ineligible for particular provisions, including (but not limited to):
- The ability to make carry forward concessional contributions, where TSB exceeds $500,000 (discussed in further detail below);
- Non-concessional contributions, where TSB exceeds $1,600,000; and
- Spouse offset.
This is relevant to SMSFs who also have an LRBA in place. New law has been introduced and upon receiving Royal Assent (which is expected to occur shortly), will include the outstanding balance of certain LRBAs in the member’s TSB.
Points to note:
- Applies to LRBAs commenced after 1 July 2018;
- Only applies to members who have satisfied a condition of release with a nil cashing restriction (i.e. over age 65 or attained preservation age and retired), or those whose interests are supported by assets that are subject to an LRBA with a related party.
- Does not apply to LRBAs in place before 1 July 2018 and refinanced after 1 July 2018.
What does this mean?
For members where this law may have application it may cause the members TSB to exceed $1.6 million and prohibit them from making non-concessional contributions (as an example). These contributions may be required in order to fund any loan repayments.
Accordingly, anyone considering undertaking an LRBA where they may fall under this new measure as they have retired or the loan is with a related party, it is worthwhile considering the impact this will have on their overall strategy.
5. Downsizer contribution – big take-up with $1 Billion contributed. Are you eligible?
The ATO has recently revealed that members have contributed $1.1 billion to superannuation from the superannuation downsizer measure since it’s introduction on 1 July 2018.
The downsizer measure allows members over age 65 to contribute up to $300,000 from the proceeds of the sale of their home to superannuation, subject to certain requirements.
- You are over age 65 at the time of the contribution;
- You or your spouse owned the property for more than 10 years;
- The property is in Australia and is not a caravan, houseboat or mobile home;
- The property is covered in full or part under the main residence exemption;
- The contribution is made from the proceeds of the sale to superannuation within 90 days;
- You make a choice to make a downsizer contribution in the approved form;
- You have not previously made a downsizer contribution.
Points to note:
- A downsizer contribution does not count towards the contribution caps;
- The member’s total super balance is not taken into account, i.e. the member can have more than $1.6 million in super and still make a downsizer contribution;
- The work test does not have to be satisfied, which is 40 hours of gainful employment in a 30-day consecutive period;
- $300,000 can be contributed by each spouse;
- The property doesn’t have to be your main residence at the time of the sale. As long as it was your main residence at some stage throughout the ownership period, whereby the member is going to claim some of the main residence exemption, this provision is available;
- Utilising this provision does not make you ineligible to make other contributions to superannuation (where you are separately eligible to make such other contributions).
6. Carry-forward concessional contributions – can you utilise this measure?
We are now into the second financial year regarding the carry-forward concessional contribution rules, which means individuals can start utilising this measure.
Since 1 July 2018, an individual can carry forward their unused concessional contributions for a maximum of five years. The individual may be able to contribute these unused amounts to superannuation provided their total superannuation balance at the commencement of the financial year in which the contribution is made is less than $500,000.
For example, if you have a total superannuation balance of $400,000 at 1 July 2019 and have made $10,000 of concessional contributions (including employer contributions) to superannuation during the 2018/2019 financial year, you may be able to make up to $40,000 of concessional contributions to superannuation during the 2019/2020 financial year ($15,000 carried forward from the 2018/2019 year and the 2019/2020 cap of $25,000).
How can we help?
If you would like to know how you are affected by these changes or need assistance, please contact your Cooper Partners engagement team.