SMEs and super: ATO’s latest warning shots

A few stats on super might surprise people:

• For the 2009-10 year, $72 billion in employer contributions were received by super funds. If compulsory super goes to 12%, that amount can only grow.
  
• Total estimated superannuation assets are around $1.28 trillion (and growing).
  
• Self-managed super funds (SMSFs) have over $400 billion in assets. As at the end of September 2010, there were about 435,000 such funds.

No wonder the Government and regulatory bodies like the Tax Office are keen to ensure the industry (especially those who set up their own self-managed or DIY super fund) complies with the laws that govern it – there’s a lot of money at stake here.

Making a super fund non-compliant (meaning it loses its concessional tax status), or disqualifying a trustee, are serious sanctions, and the ATO says it does not impose them lightly. That might be so, but SMEs shouldn’t take too much comfort from that. The time for the ATO to take a tough line on super fund compliance is already here (as is outlined below).

SMSF target areas for the ATO

The ATO has flagged a number of major areas it will be reviewing closely:

1. Loans

The superannuation laws contain restrictions on borrowings by super funds and also restrict super funds from lending money to members of the fund or their relatives. The ATO says it has 300 audits planned, together with 200 reviews, 1,600 mail-out cases and a follow-up program relating to the mail-out cases it conducted in 2008-09. Mail-out cases are for self-managed funds with loans below the risk thresholds for audit/review.

The ATO asks trustees to consider whether their reported loan is in line with the superannuation laws and whether they have implemented reasonable safeguards to protect the fund’s assets. Where trustees are in breach, the letter will encourage them to take appropriate steps to rectify the contravention – this may involve a voluntary disclosure.

2. Breaches of the in-house asset rules

There are rules called the “in-house asset rules” as to the proportion of a super fund’s assets that may be lent by the trustee to an employer-sponsor of the fund or an associate of the employer. The ATO says it has found in most instances that trustees have effectively been using their retirement benefits to support their related businesses (this is danger territory for SMEs who may be in financial difficulty) and are clearly exceeding the 5% limit that the law specifies.

Where the breaches are significant, the ATO has been imposing serious sanctions, such as making the fund non-complying. In fact, the ATO said a significant number of the 185 funds it made non-complying in the 2009-10 financial year had breached the in-house asset rules.

In the majority of cases, the ATO said the significance and length of the breaches (often multiple), the level of carelessness or recklessness shown by the super fund trustees towards their obligations, and their attitudes towards addressing their compliance problems, led it to conclude that making the fund non-complying was “the most appropriate course of action to take”. SMEs should take note of this.

3. New super funds

The growth of superannuation has meant that the rate at which people are setting up their own SMSFs is high. In fact, SMSFs are growing at about 5%-10% per annum. That’s impressive, but the ATO is well aware that not everyone fully understands the rules when setting up a fund.

Again, SMEs beware. As a result, the ATO has a specific early intervention strategy to focus on what it regards as “at-risk” new funds, particularly in the context of addressing risks of illegal early release of superannuation. The ATO considers that schemes for the illegal early release of super benefits are a “serious risk” to the health of the superannuation system and has allocated significant resources to addressing it. When funds lodge their first returns, the ATO assesses whether there are any apparent compliance issues of concern.

Where it detects an issue, the ATO withholds providing the notice of compliance to the fund until it is satisfied that everything is in order. While the ATO acknowledges that this happens in only a minority of cases, the whole process of setting up and running a fund may not quite be as automatic as some may think!

Repairs to fund assets

On the flipside of the ATO’s compliance action coin so to speak, the Tax Commissioner says that SMSFs that own flood or cyclone-damaged buildings under the limited recourse borrowing arrangements under superannuation laws (specifically, under ss 67A and 67B of the Superannuation Industry (Supervision) Act 1993) may be prevented from making improvements. This is because the law makes a distinction in the tax treatment of repairs and improvements. While the Commissioner does not have a discretion to treat an improvement as a repair, he said the Tax Office will not be seeking to make “fine distinctions” having regard to what is available to repair what has been damaged.

Where an SMSF trustee needs to borrow funds to finance repairs and those borrowings contravene the limited recourse borrowing provisions due to a natural disaster, the Commissioner said he would be “favourably inclined” to exercise his discretion under the law to continue to treat the super fund as complying. ATO Commissioner, Michael D’Ascenzo said the Tax Office is currently reviewing this matter with APRA and Treasury to ensure no unintended consequences arise. So, some likely good news for those SME fund trustees that were affected by the floods or Cyclone Yasi.

Excess super contributions tax

This issue is proving to be a major headache for many people. Breaching the superannuation contribution limits can bring a tax rate as high as 93%. People are making inadvertent innocent mistakes and breaching the limits, but still have to pay the penalty.

The law is tightly drafted so that the Commissioner does not have much discretion to help people out. Those in the industry are holding out for some legislative relief from these draconian laws, but who knows if (at all) that might happen.

The Tax Commissioner says poor reporting practices by super funds in relation to member contributions is one reason for taxpayers being identified as potentially having excess contributions tax (ECT) liabilities. Other issues include:

• taxpayers failing to take into account all available information when planning their contributions for a financial year;
• taxpayers not completing their income tax returns correctly. This isn’t easy at the best of times, but getting it wrong regarding superannuation contributions has an extra sting;
• taxpayers not providing super funds with sufficient contribution information;
• concessional contributions – salary sacrifice arrangements and the timing of contributions made by employers (eg. contributions made in respect of one financial year not being received by the fund until the next year);
• non-concessional contributions – taxpayers not acting on professional advice and super funds not returning contributions which the fund was unable to accept at law.

The Commissioner noted that he can only exercise his discretion to disregard or reallocate super contributions (and thereby may allow people not to breach the limits) where there are “special circumstances”. He says the discretion is very limited and does not typically extend to circumstances of inadvertence, error, miscalculation or poor professional advice.

Nevertheless, the Commissioner said he will generally exercise his discretion where an employer makes a one-off bring-forward of super contributions over which the person had no control. However, the Tax Office warned that if this happens again in another financial year, it could be more difficult to find that “special circumstances” exist.

D’Ascenzo said taxpayers apply to the Commissioner to exercise his discretion in about 8% of ECT assessments. Of these discretion requests, about 20% have been successful so far. This means about 98% of excess super contributions tax assessments are maintained.

Lodgment

The last “warning shot” I want to mention concerns the lodgment of super fund returns. Should be a simple matter really, but it ain’t necessarily so! While lodgment rates remain solid, the Tax Commissioner says that 9.1% of SMSF returns are yet to be lodged for the 2008-09 income year. He said 13 default assessments had been issued to funds that failed to respond to ATO warning letters issued in October 2010. Further default assessments are expected to be issued in the coming months.

And as if that’s not enough warning, the Tax Office will be prosecuting fund trustees who fail to meet their fund’s lodgment obligations – with penalties up to $5,500 for an individual, $27,500 for a company, and/or up to 12 months jail. This is serious stuff!

As I’ve warned before, SMEs simply must take extreme care when dealing with their super.

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions .

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