If you’ve been lending to your SMSF take note
In this low interest rate environment, the ability of self-managed super funds (SMSFs) to generate returns sufficient to maintain lifestyle expectations is paramount. Thus any issues impacting this, even if subtle, are highly relevant.
People with SMSFs, plus accountants and financial advisors who may have missed a quiet but significant about-face by the ATO just a few days before Christmas, could benefit by reading on.
Until then SMSF trustees were able to lend money to their SMSFs (themselves or via a “related” party such as a business or trust) without charging the super fund any interest. This meant owners of SMSFs could effectively avoid strict contribution limit caps, thus vastly to increase money they were able put into their super funds.
The ATO’s December 2014 about-face was on December 2012 decisions that loans with zero per cent interest rates could be deemed legitimate borrowings – and therefore within the spirit of rules applying to SMSFs.
However in Interpretive Decisions (ATOID) 2014/39 and 2014/40, the ATO now states the arrangement is no longer acceptable, and money deposited in SMSFs by such a process will henceforth be regarded as “non-arm’s length income”.
About this income
Within a super fund this sort of income is taxed at 47% - the highest marginal tax rate, including the current “temporary budget levy” of 2% for high-income earners.
This compares with a 15% income tax rate for super in general, so the new regime could heavily penalise some SMSF trustees.
Macks Advisory has no figures on how many of the nation’s 539,000 super funds have been exploiting the former loophole to inject money above the restrictive concessional contribution caps ($30,000 for people under 50, $35,000 for the over 50s), or the non-concessional contribution cap of $180,000 a year.
But the fact remains that many super fund members operating with cheap, even 0% loans, have been able to build nest eggs faster in the low tax environment applying in superannuation.
The fund pays no tax when the member of the fund turns 60 and triggers a pension and can then return the loaned money to the lender tax free.
The situation now
The ATO is now saying loans between SMSFs and related parties must be made with provisions broadly comparable to those applying should the funds seek bank loans.
In other words loans should be at realistic interest rates, probably involving mortgages, application of maximum loan-to-value ratios (LVRs), along with realistic terms and provisions./p>
This new ATO decision puts an end to what many people may still believe (many of them business owners) that zero-interest loans provided an allowable way to get extra money into super.
But henceforth SMSFs must function using realistic interest rates, must repay loans under specified arrangements, and may possibly need “personal guarantees” from SMSF trustees that should a loan go bad, any money still owed on it can be repaid to the lender.
A matter of major concern
At Macks Advisory it’s our expectation that as a result of so-called “stronger super” changes effective from 1 January, there will be increased numbers of court actions where insolvency practitioners find themselves compelled to do battle with holders of super fund assets.
Once SMSFs get involved in commercial deals and the deals unravel, insolvency practitioners will, in certain circumstances, need to gain access to such assets.
Readers interested in a recent court decision on what can happen when a business borrows from a bank to make large super contributions to an SMSF, and the business then collapses, can study the case in this newsletter. (See headline: The nexus between banks and SMSFs can be problematic.)
A parliamentary committee has heard how last year, as a result of company insolvencies, employees were never able to recover $190m in superannuation owed to them. And they lost a further $15m simply because pursuit of the money was uneconomic.
The temptation is for an employer under financial pressures, to use money that should have been set aside for employees’ super, to try to save the businesses.
Regulations governing all proposed changes to SMSFs have yet to be finalised, and although employers are required to add more details to pay slips indicating how they’re making super payments, employees often can’t be sure correct payments are actually being received regularly by a superannuation entity.
Some recommendations
We recommend, accountants, solicitors and business advisers ensure clients who unfailingly forward employees’ super entitlements to appropriate destinations are aware of ‘stronger super” changes effective from the beginning of this year.
We also recommend that good, responsible employers enhance their reputations among all associated with them and their businesses, especially staff, by henceforth stating on pay slips that instead of superannuation payments being regularly remitted quarterly, they’ll be paid monthly, or even weekly.
It’s a discipline that not only helps employers resist the temptation to use this money to increase cash flow in times of financial stress, but acts as an early warning sign that if they can’t maintain stated payments regularly, there’s an urgent need to consider operational efficiency and business reconstruction.
Failure of a business to regularly meet its superannuation commitments is one of the first signs that it’s in imminent danger of financial collapse, consequent external administration, or ultimate liquidation.
True, improvements to the Corporations Act have ensured employees’ financial interests in creditors’ hierarchy, should their employer go belly up. However, nothing can be done for them if there’s no available money because of insolvency procedures.
Accordingly we recommend that employees seek to discover whether their super fund has a website allowing member access, and if so, that they monitor the site regularly to ensure employer contributions are lodged regularly into their accounts.
Clearly and importantly, you should ensure that if you have a loan of the type discussed above in place, you should prudently ensure that the terms of the loan are changed to fit the ATO’s criteria, which are effectively commercial terms.
For more information, contact Macks Advisory on 08 8231 3323 or visit our office at Level 11, 99 Gawler Place, Adelaide SA 5000.
