An in-specie transfer

PORTFOLIO POINT: Super fund members have been given a 12-month reprieve on in-specie transfers. The legislation is too hard to frame.

As predicted here just a few weeks ago, the ban on SMSFs making in-specie transfers has been put off by a year.

SMSFs will be able to make in-specie transfers of shares (and other assets) into super until at least June 30, 2013, following a decision by Treasury to delay the introduction of legislation.

So, you can still have transferring some of your favourite stocks into super on your to-do list.

Treasury, insiders say, is struggling with the framing of the legislation. They found a bunch of unexpected roadblocks. And I’m beginning to get a better sense of why.

The delay was announced, without fanfare, through the Stronger Super website in recent days. Jeremy Cooper proposed a ban on in-specie transfers in his 2010 Super System Review, which the government accepted. And Treasury has been working with industry for the last nine months to try to figure out how to get the legislation right. But it appears they’re still a long, long way from success.

For the column covering the government’s initial decision, click here. They were labelling (some) SMSF trustees “frauds” and “liars”.

Essentially, the government wants to ban the practice because the ability to manipulate concessional and non-concessional contribution limits in super using in-specie transfer rules is almost infinite. Equally, they could manipulate capital gains tax. Particularly when highly volatile stocks are used.

And, following the logic, it was the uber-wealthy that were in the best position to take advantage of the situation. Literally, the wealthier you were (are), the more you could abuse the system.

Let’s show a ridiculous extreme, shall we?

Take someone worth, say, $25,000,000. They’re interested in shares. On October 1, 2011, they spend $4.5 million buying $450,000 worth each of 10 stocks in their personal names.

One of those 10 listed companies gets lucky. A drilling test hits gold (literally) and all of a sudden the shares go from 5c a share to 50c (maybe more, but we’ll stick with a 10-bagger for now) through January the following year.

The shares in that company have just risen in value from $450,000 to $4.5 million. (I haven’t chosen the $450,000 out of thin air, but I’ll come back to that shortly.) The rest of the portfolio stays roughly where they are, but that’s kind of irrelevant.

The in-specie rules, as they currently exist, aren’t tight enough to stop this person declaring that they transferred the shares, in-specie, when the shares were worth $450,000. That is, they could potentially sign a transfer form in March 2012, but date it December 2011, before the shares started their run. Then they send it to the share registrar to process the transfer.

The December valuation, which had the share price at 5c a share, meant the portfolio was still worth $450,000. When they put the share transfer forms in to be processed (generally by Computershare or Link Market Services), the “date of transfer” says December, 2011, as that’s when the trustees dated the forms, even though it wasn’t actually sent in to the registry until the March, after the shares had increased 10-fold.

Now, before we finish this story ... I need to explain the reason the $450,000 worth of shares was chosen as a value.

That is the value of the three-year pull forward rule for non-concessional contributions. The amount of $450,000 is what you are allowed to contribute to super as after-tax contributions, potentially, in one hit. It will cover your non-concessional contributions for three years. If you made a contribution of $450,000 today, that would be the total of NCCs that you could make for the 2013, 2014 and 2015 financial years.

The value on the shares that they have transferred, as at the date of the transfer, was $450,000.

But why would our investor in this example care about that! They have managed to completely, not-quite-legally, but in a way that is very difficult to detect and prosecute, by-pass the NCC limits and have managed to get $4.5 million into super.

If they did that three or more years ago, they could repeat the process again now.

And then, once it’s in super, the real benefits potentially begin. They can sell the shares now worth $4.5 million and potentially pay the total sum of $0 in capital gains tax (if the fund is in pension phase), or potentially a maximum CGT bill of around $607,500 (($4,500,000 minus $450,000) x 15%). Small bickies for getting 4.5 very large ones into your super fund where it will, eventually, provide a tax-free income stream for the member.

Anyway, the fact is a very small number of the uber-wealthy might have been doing it for a while and defrauding the tax office. And that’s why the government/ Treasury wants to outlaw the practice outright. And quickly.

It is possible for almost anyone to have done in the past. However, it would probably involve smaller numbers ... or extreme luck. And it would be no less illegal.

Take $150,000 worth of Telstra shares, for example. In August last year, they were worth, for a short period, less than $2.75 a share. They are now worth $3.80.

If a person transferred $150,000 worth of Telstra shares at $2.75 (which is one year’s worth of non-concessional contributions), then it would now be worth $207,000. And that could be in-specie transferred into your SMSF. But please remember the warning above. Wrongly dating a transfer form is illegal and fraud.

So, what are the solutions?

The one I’ve asked industry professionals about would be getting the share registry companies (Computershare and Link, predominantly) to write to trustees at the time they effect the transfer to say that the shares were transferred through at such-and-such a price, which could be the closing price the previous day to the transfer taking place. To take the Telstra example ... if they had been transferred on Monday, then the closing price for the transfer would be $3.83.

Treasury has said “no” because people wouldn’t necessarily know what price the shares were transferred until after the event, which could lead to inadvertent and unintentional breaches of concessional and non-concessional contributions caps. Which shows Treasury is trying to be reasonable.

The Self-Managed Superannuation Funds Professional Association of Australia (SPAA) has argued that the new rule should be that the paperwork must be received no more than five days after the transfer document is signed. That would mean that the paperwork couldn’t sit on the “kitchen bench”, as in our example above, for four months before being sent to the registry.

SPAA argues that this could potentially be monitored by SMSF auditors, who have their own very good reasons for insuring compliance (that is, they could have their ability to act as SMSF auditors revoked).

The legislation will involve the re-writing of several acts of parliament, including the Superannuation Industry (Supervision) Act, the Corporations Act, any rules which cover “wash sales” (see 18/4/12) and the Market Integrity Rules.

Treasury has a job ahead of it. Presumably delaying things by another year will allow them to sort some of those problems out to find a reasonable solution that won’t mean that those who are trying to play by the rules don’t get lumped in with the “frauds” and “cheats”.

The government has officially deferred the ban on off-market transfers of listed shares into self-managed funds until July 1, 2013. The confirmation was put up on the Stronger Super website, amid a range of amended start dates for legislation surrounding SMSFs, though the deferral was widely expected given the previously expected start date of July 1, 2012, had passed. Measures to give the Australian Taxation Office more powers to issue administrative penalties, directives and mandatory education that were also scheduled for July 1, 2012, have been delayed a year as well. The proposed rules stipulated that related-party transfers must be conducted through an underlying market where one exists, or must be supported by valuation where one does not. However SMSF Academy head Aaron Dunn explains there are “some significant roadblocks around market manipulation rules” preventing it going ahead. “The ongoing drafting issues being experienced by Treasury can hopefully lead to a sensible outcome rather than applying a 'sledgehammer’ approach to off-market transfers for SMSF trustees,” Dunn writes. At the same time, the government has warned those helping or encouraging others to illegally access superannuation face tough new penalties. Financial Services and Superannuation Minister Bill Shorten says promoters of illegal early release superannuation schemes have been exploiting vulnerable people. “Promoters of these schemes generally target non-English speaking communities and take advantage of those who may not be fully aware of the rules regarding accessing superannuation benefits,” he said. The new penalty legislation is awaiting royal assent. The Australian Securities and Investments Commission (ASIC) has obtained court orders against two Queensland SMSF advice companies, amid concerns they misled investors. ASIC says it is concerned Royale Capital and ActiveSuper were offering clients shares based in the US and British Virgin Islands without appropriate disclosure lodged with ASIC. The court orders prevent the companies from dealing with any funds in the accounts of their clients, as ASIC’s investigation into how funds invested with Royale and Active have been used continues and the matter will return to the federal court on July 27. Macquarie NAB has launched a new margin loan product for the self-managed sector. The NAB Super Lever, from NAB Equity Lending, allows minimum loans of $20,000 for the purchase of approved listed shares or managed funds in an SMSF. The product is 'interest only’, which provides more control over repayment, and is designed to enable investors to test out gearing with small transactions, and into shares rather than property. However, Andrew Main writing in The Australian warns investors that it pays to be careful of any leverage inside super, and to seek further advice. Investment manager Instreet is offering a new structured product it calls “SMSF friendly”. “Feedback from financial planners suggests investors want to have a lower break-even point as the markets remain subdued,” managing director George Lucas says. The new product references a commodities index, and Insteet says it can provide more transparent exposure to alternative assets than a hedge fund. An SMSF adviser in New South Wales has pleaded guilty to obtaining financial advantage by deception. Craig Dangar obtained a total of $250,000 from recommending two SMSF clients purchase shares he owned, misrepresenting the true owner of the shares, and told one they would experience likely capital growth. The charges stemmed from an ASIC investigation into Dangar from 2004 to 2007, and he will be sentenced July 20.

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are highly complex and require high-level technical compliance.

Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking.