The latest round of superannuation changes don’t impact every SMSF, but for the ones they do, complexity abounds.
In the last few weeks, we saw three changes to super, which were originally announced in the 2017-18 Federal Budget.
The first allows you to reduce your superannuation guarantee contributions below your concessional contributions cap if you end up with an excess. The next was a change to non-arm’s length income which mainly impacted SMSFs. The last was a change to calculating your Total Super Balance if your fund commenced a limited recourse borrowing arrangement (LRBA) on or after 1 July 2018.
These changes will have little impact on most fund members but if they apply, you’ll need to be careful as they are complex.
Changes to the Super Guarantee
If you are a high-income earner and have more than one employer, you may find that your super guarantee contributions exceed your concessional contributions cap. If that’s the case, you may end up paying excess concessional contributions tax.
However, the recent change to the super guarantee rules allow you to nominate the wages and which employer(s) is to be excluded from the calculation. It applies if you have more than one employer and expect the combined amount of your employers’ compulsory super contributions to exceed your annual concessional contributions cap for the financial year.
To obtain the exemption you’ll need to apply for an exemption certificate from the ATO to release your employer(s) from paying super guarantee contributions for you. But contributions are still required to be paid by at least one employer. Before you decide to apply for the exemption certificate, make sure you talk to your employer as adjustments may be needed to your pay and any other salary entitlements.
You’ll need to send your exemption application to the ATO at least 60 days before the end of the quarter you are requesting the exemption. Your application needs to tell the ATO which employer the exemption certificate applies to and the quarter or quarters in the financial year for which the exemption(s) is required.
If your application is approved, the ATO will send you and your exempted employer a non-revocable certificate. This does not stop your employer from making super contributions for you, but it does mean that your employer is not required to make compulsory contributions for super guarantee purposes. But your employer needs to meet any other super obligations under a workplace award or agreement or any contributions your employer has agreed to make with your super fund.
The first quarter that the exemption applies to is the March 2020 quarter which commences on 1 January 2020. For this quarter the ATO will accept exemption applications if you send them in before 18 November 2019.
The ATO application form for the exemption is available from the ATO’s website from October 21 this year, but if you need it earlier contact the ATO on 13 10 20 which is their enquiry number.
Non-arm’s length income
Non-arm’s length income is not new to the tax law, as it has applied to superannuation funds for many years where the income and capital gains earned on any investment is greater than a commercial rate of return. But now it has been extended and backdated to 1 July 2018 to include situations where the net income from investments is greater than if it were made on an arm’s length commercial basis. Tax payable on non-arm’s length income is 45% and it doesn’t matter whether the investment supports the accumulation or pension phase of the fund.
To illustrate how the new legislation applies, here are some examples:
1. LRBAs not on a commercial basis
Ben’s SMSF purchased an office building at commercial rates for $1.5 million from an unrelated third party on 1 July 2017 under a LRBA. The office is rented out on commercial terms for $2,000 per week ($104,000 per year).
The terms of the LRBA were that:
- it was an interest free loan,
- repayments on the loan occurred every 5 years, and
- the property was 100% geared.
This arrangement is considered not to be on a commercial basis and does not meet the ATO safe harbour guidelines for real estate and related party LRBAs.
The net income received by Ben’s SMSF will be taxed as non-arm’s length income because the expenses incurred by the fund are not consistent with a normal arm’s length commercial transaction. Therefore, the net income received from the rent after deductible expenses relating to the property will be taxed at 45%.
2. Unit trust units not purchased on an arm’s length basis
Sakina’s SMSF is offered units in a fixed unit trust but because she is a high wealth customer her broker sells them to her SMSF for a lot less than the advertised price of the units. It is considered the arrangement with the broker is a scheme as she has paid the difference in the price of the units against other investments purchased in her own name.
As Sakina’s SMSF did not pay expenses to purchase the units on an arm’s length basis any distributions from the unit trust and any net capital gain made on sale of the units will be taxed as non-arm’s length income. This is apart from the fact that the distributions received from the unit trust would be the same whether they had been purchased on arm’s length terms.
3. Provision of services free of charge by trustee
The non-arm’s length income rules do not apply where the services provided by the fund trustees are purely internal. The reason is that there is no transaction with another party whether on an arm’s length or non-arm’s length basis.
An example would be clerical work, such as bookkeeping, maintaining minutes or other activities undertaken by a fund trustee. But if the trustee outsources these functions to a third party in their professional capacity, then the non-arm’s length requirements may apply.
The non-arm’s length income rules may apply where a trustee of an SMSF is a qualified accountant and the fund engages her firm to prepare the fund accounts at a discount to the normal arm’s length cost of normally providing those services. This arrangement would treat the fund’s income as non-arm’s length income. However, if the cost was at normal commercial rates the non-arm’s length provisions would not apply.
Another example could be where an SMSF owns a rental property and the trustee is a real estate agent. The property is rented through the trustee’s real estate company, but the fee charged is about 50% of that for arm’s length clients. In this situation the non-arm’s length requirements will apply.
The ATO has recently indicated that it will not enforce these provisions concerning outsourced non-arm’s length expenses for the 2018-19 and 2019-20 financial years. However, trustees should be reviewing any outsourced functions to adjust the fund’s non-arm’s length arrangements from 1 July 2020 otherwise the new rules could apply.
4. Purchasing or transferring an investment for less than its market value
If a fund purchases or has an investment transferred to it for less than its market value because of non-arm’s length dealings, any income received from the investment will be treated as non-arm’s length income. Any capital gains from the sale or transfer of the investment will also be treated as non-arm’s length income.
The Superannuation Industry (Supervision) Act (SIS Act) specifically prohibits the fund acquiring investments from related parties. The exclusions to this general rule allow the fund to acquire commercial real estate, listed securities and in-house assets from related parties providing it is at market value.
Therefore if the fund acquired an investment from a related party, whether permitted or otherwise by the SIS Act, that was not on an arm’s length basis any net income earned from the investment will also be taxed as non-arm’s length income.
5. In specie contributions
The value of an investment can be transferred to the fund as a contribution. A superannuation fund may purchase an investment or transfer it as an in-specie contribution. If an SMSF purchases an investment for less than its market value or reports the in-specie contribution at less than market value, any income and capital gains earned from the investment will be taxed as non-arm’s length income.
As a trustee of your SMSF any transactions since 1 July 2018 including the purchase and sale of investments and the income earned on fund investments should be reviewed to work out whether the investments have been made on an arm’s length basis. Don’t forget the penalty for non-arm’s length income and capital gains is 45%.
LRBAs and total super balance
Your total super balance regulates levels of contributions that you can make to your fund including whether you will receive the co contribution and low-income superannuation tax offset. It also determines the timing of when your fund needs to report transfer balance cap amounts and whether the proportioning rule must be used to calculate the fund’s exempt current pension income.
Every 30 June your total super balance is calculated as the total of your accumulation balance, pension balances and amounts that are in transit between funds. The recent changes now include a share of outstanding balances your fund has in certain LRBAs that commenced from 1 July 2018. However, it should be made clear that is does not include all LRBAs commenced by your fund and whether the new rules apply depends on how assets have been allocated between accumulation and retirement phases.
To work out whether your share of the fund’s LRBA balance is added to your total superannuation balance depends on whether you have satisfied a condition of release with a nil cashing restriction, such as retirement or reaching age 65. This rule applies where your fund has obtained the borrowing from a third-party lender. However, if the LRBA loan is between your fund and an associate then an adjustment will be made to your total superannuation balance irrespective of whether you have met a nil condition of release. An associate includes fund members, trustees, their relatives and entities such as companies and trusts they control.
If an LRBA has commenced in your SMSF and qualifies under the new rules your total super balance will be increased proportionately depending on the fund’s super balances and the outstanding balance of the LRBA.
Here is an example on how the new legislation applies to calculate a member’s total superannuation balance involving a post 1 July 2018 LRBA.
Example: single member superannuation fund
Mark, who is 52, is the sole member of his SMSF.
On 31 December 2018 Mark lends $900,000 to his SMSF for purposes of an LRBA to purchase a commercial property valued at $2 million. As at 30 June 2019 the outstanding balance of the LRBA is $850,000.
The value of Mark’s superannuation balance in the SMSF on 30 June 2019 is $2.25 million which includes the net value of the commercial property ($2 million less the outstanding balance of the loan of $850,000).
As the LRBA loan has been made by an associate, the outstanding balance of the loan as at 30 June 2019 will be added to Mark’s total superannuation balance. This will mean Mark’s total superannuation balance on 30 June 2019 is $3.1 million which is his fund balance of $2.25 million plus the outstanding loan balance of $850,000
As you can see, understanding whether your total superannuation balance will be adjusted because the fund has commenced an LRBA from 1 July 2018 can be difficult to understand. Therefore, it is worthwhile to seek advice to see how the changes to total super balance, superannuation guarantee or non-arm’s length income rules may impact on you or your SMSF.
Subscribe to SMSF News to receive my latest articlesGraeme Colley, Executive Manager, SMSF Technical and Private Wealth, SuperConcepts
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