In the early days of the Global Financial Crisis, Rahm Emanuel – then chief of staff to President-elect Barack Obama – was quoted as saying, “Never waste a crisis”. In doing so, he tapped into that distinctively American tendency to find opportunity in crisis, and to view challenges as transformative rather than merely destructive.
It may be difficult at present to see how this lesson can be applied to self-managed superannuation. Nonetheless, depending on how circumstances change, funds that can preserve their capital now may find that investment opportunities abound in the future.
For the time being, however, trustees should occupy themselves with the considerable list of superannuation measures put forward by the Government in direct response to the COVID-19 pandemic. Although some of these proposals – such as temporary early access to super balances – are unlikely to apply to the majority of SMSF members, there are still a number of measures that may allow trustees to protect their fund balances, or deal with related parties struggling to meet payment obligations.
Reduced Minimum Drawdown Rates
For the 2019-20 and 2020-21 years, the minimum drawdown requirements for pensions have been reduced by half. The approach gives members some leeway to avoid crystallising loses while the market is low. This may also be useful for members who have seen their expenditure fall during the lockdown period – consider the retired couple that cancelled their annual overseas holiday due to travel restrictions.
Some older SMSF deeds may stipulate that the trustee must pay any account-based pensions at the minimum required drawdown rate. It is not obvious whether the 50% discount would become the relevant rate for the purposes of those deeds. Therefore, if an SMSF deed has a clause to that effect, the trustee should consider updating the governing rules to avoid any ambiguity.
Pumali Mangalagama of Partners Wealth Group’s Audit team explores this issue here
Temporary Early Access to Super
Superannuation fund members whose financial circumstances have been adversely affected by COVID-19 may be eligible to access up to $20,000 of their preserved superannuation benefits. This figure is made up of two separate releases of $10,000 for the 2019/20 year, and $10,000 for the 2020/21 year.
Early access is available on compassionate grounds. Again, trustees should ensure that their deeds allow payment on compassionate grounds, and update if the deed does not.
Jacklyn Li of Partners Wealth Group’s Audit team provides further details here
Temporary Rent Reductions
Many SMSFs own residential or commercial property. Some of these funds will have received requests for, or may be considering granting, rental relief to their tenants. Depending on whether the tenant is a related or unrelated party, and whether borrowings are owed against that property, several regulatory issues may arise.
It is useful to remind ourselves of first principles. Trustees of superannuation funds must maintain their investments on an arm’s length basis. They must not provide financial assistance to related parties. They must operate the fund in accordance with the sole purpose test.
These obligations would seem to prohibit granting rental relief. Contrary to this position is the Government’s Rental Relief Code which mandates rental relief in certain circumstances.
An SMSF with an unrelated tenant is likely already dealing with that party on an arm’s length basis. Subject to its obligations under the Government’s mandatory rental relief code, in this case the trustee should make a commercial decision as to whether to grant relief. For example, the trustee may determine that rental relief is appropriate if it allows the tenant to survive, thereby ultimately maximising returns to the fund. Trustees may need to balance these considerations with any loan repayment obligations (see below).
Matters are a little trickier with related party tenants. The SMSF trustee as landlord will need to deal with a related party tenant on an arm’s length basis at all times. Any rental relief must therefore be no more generous than what the SMSF trustee would offer to an unrelated tenant. This arrangement should be documented, and evidence benchmarking any new rental terms should be included in the records for the fund. Trustees should consider and document or minute their conclusions as to whether:
- an alternative tenant can be found; and
- what rental relief the prevailing market would support. Expert input from a real estate agent should be put on file. The Government’s Rental Relief Code may provide a useful reference point.
The existing lease may need to be amended to ensure that no deferred rental amount constitutes a loan from the landlord. The ATO has advised that any amendment should be documented.
Rental relief should first be requested by the tenant (rather than offered without solicitation by the SMSF trustee/landlord). If COVID-19 has not adversely affected the financial position of the tenant, granting rental relief may not be justifiable and runs a higher risk of breaching one or more prohibitions in the Superannuation Industry (Supervision) Act.
Alex Swansson of Partners Wealth Group’s Audit Team has further comments on this topic here
Rental Relief and 13.22C Trusts
A question arises as to whether the trustee of a non-geared unit trust breaches SIS Reg 13.22C by deferring or waiving rental repayments from a related party tenant. The ATO has advised that an in-house asset issue will not arise if the unit trust grants the tenant a waiver or deferral of rent.
Given the strict prohibitions on such trusts lending, it is suggested that the rental payments should be actively addressed (and rescheduled where commercial and appropriate) to ensure that no outstanding amount arises and remains unpaid.
This means amending existing lease arrangements (and documenting those arrangements) rather than simply leaving matters unamended and trying to correct or adjust in the accounts of the trust.
The ATO has advised that changes to lease agreements (including the reason for those changes) should be documented. In practice, the written agreement itself will set out the variation process, although this is generally by formal amendment signed by the parties.
Limited Recourse Borrowing Arrangements Repayment Relief
As a starting point, superannuation funds with outstanding borrowings are not automatically relieved of the obligation to repay loan amounts. Funds that need relief must seek that from their lender.
If an SMSF trustee borrowed from a bank or financial institution, they may need to request repayment relief from their lender if they are experiencing cash flow problems. Different banks will have different policies. Trustees should first familiarise themselves with the bank’s announcements as well as the terms of their loan agreement. Particular attention should be paid to any provision describing default events, as seeking relief may be in itself a default event. A common theme in recent reports is that banks will only grant relief if the borrower is unable to make repayments without that concession.
Again, matters are trickier if the lender is a related party. These loans have been subjected to sustained scrutiny by the ATO of late out of concern that many SMSFs had loans that were not commercial. The ATO advised that uncommercial loans would be deemed to generate non-arm’s length income, which is taxed at the highest marginal rate. The standard approach to managing this risk has been to maintain loans in accordance with the safe harbour rates set out in Practical Compliance Guideline PCG 2016/5. These guidelines make no mention of repayment relief, raising the spectre that any such relief would be uncommercial and would lead to non-arm’s length income.
The ATO has suggested that repayment relief that is consistent with what a commercial bank would offer is acceptable. On their website, they state that “these terms currently include temporary repayment deferrals for most businesses of up to 6 months, with unpaid interest being capitalised on the loan.” Again, in order to replicate the approach of most banks, this relief should only be granted if the borrower is unable to make repayments.
The ATO indicates that these amendments should be documented, that interest should continue to accrue and that all outstanding principal and interest repayments should be made as soon as possible.
The ATO’s past advice in relation to PCG 2016/5 has been that loans that were not in accordance with the safe harbour rates should be benchmarked against documented loan offers made to the SMSF trustee. This was to demonstrate that the loan terms used were commercial. In this regard, it is suggested that any repayment relief should be benchmarked against documented banking practice, or at least advisory material from the ATO.
If a further relief extension beyond the initial six months is required, it should be offered on terms that are commercial at that time.
The relief should first be requested by the borrower, rather than offered by the lender. The lender should consider the request and document its reasons for the relief (if any) that if offers.
As noted above, investment strategies were the object of increased ATO attention before the COVID-19 pandemic broke. The ATO was concerned that investment strategies had become a pro forma compliance document that did not accurately describe the investment plan of the trustee. In particular, the ATO advised that investment strategies:
- should not use generic ‘0-100%’ values for investments in asset categories;
- should reflect and justify the actual investment intentions of the trustee; and
- should be reviewed regularly (at least annually) and updated as necessary.
With the recent economic downturn, many funds will no longer be invested in accordance with their targeted asset ranges. As listed securities have declined in value, other assets (such as cash) will now represent a larger percentage of the overall value of the fund. Although it is not necessarily a problem if a fund departs for a short while from its stated investment strategy, it is nonetheless incumbent on all SMSF trustees to review and update their investment strategies as necessary.
Similar to the highlighted issues regarding investment strategies, some SMSFs may now find they have exceeded the 5% cap on in-house assets. This is because as the value of listed securities has declined, so the relative value of other assets (including in-house assets) may have increased as a portion of the overall value of the fund.
Typically, if an SMSF has breached the in-house asset cap as at 30 June of a given year, it must devise and implement a rectification plan to correct this by 30 June of the following year. However, the ATO has advised that it will not take action in the present circumstances if the rectification plan was not implemented because either:
- the rectification plan could not be implemented because the market has not yet recovered; or
- it was unnecessary to implement the plan because the market recovered and in so doing the fund’s in-house assets fell below the 5% threshold.
SMSF Residency Requirements
Without wanting to discuss an SMSF’s residency requirements in detail, a superannuation fund must be an Australian fund in order to qualify for tax concessional treatment. Trustees and members who are located overseas for a sustained or indefinite period have long presented challenges in this regard. In particular, trustees who were overseas for an extended time but were expecting to return to Australia within 2 years may find that they are unable to return within that timeframe due to coronavirus-related travel restrictions.
In light of overseas countries imposing travel bans, the ATO will not generally not apply compliance resources in instances where trustees are stranded overseas due to COVID-19 travel restrictions.
Transfer Balance Cap
At the time that the Transfer Balance Cap was introduced in 2016, it was acknowledged that a severe macroeconomic shock could adversely affect members who had exhausted their cap.
At [3.102]-[3.103] of the Explanatory Memorandum for the Treasury Laws Amendment (Fair and sustainable Superannuation) Bill 2016, it was noted that the Government would review the Transfer Balance Cap in such a situation.
Although no announcement has been made, it would seem likely that the Government will need to consider the implications of COVID-19 on the Transfer Balance Cap.
Guidance From the ATO
The ATO has provided further commentary on several of the above issues. These comments can be accessed here
The ATO has indicated that, during financial years 2019/20 and 2020/21, it will not apply compliance resources to a number of the issues discussed above. It should be noted that when in the past the ATO has provided similar assurances, this has not prevented it from undertaking a wholesale audit of a fund if some other compliance anomaly is detected. In other words, although the ATO will not specifically seek out breaches of the above standards, it may still issue penalties for such breaches if discovered in the context of an investigation into other issues relating to a given fund.
It should also be noted that a single action by a trustee may simultaneously breach several provisions of the Superannuation Industry (Supervision) Act, and that an exemption in relation to one provision does not exempt that same action from breaching another provision of the Act (for example, no exemption of the Sole Purpose Test has been made).
Where to now?
These COVID-19 measures afford SMSF Trustees a number of opportunities to either protect the balance of their funds or to manage their cash flow. This may be crucial in positioning the fund as markets start to emerge from the pandemic (although it should be noted that the virus will set its own timeframe).
Partners Wealth Group's legal team can help SMSF Trustees that need to document variations to lease or loan arrangements. We can also review and update SMSF Governing Rules to ensure trustees can take advantage of temporary early access to super or reduced minimum pension payment provisions. Please contact Christian Chenu on 0417 015 997 or firstname.lastname@example.org for further details.