ATO plays chief SMSF detective

Summary: The ATO cuts some new DIY fund members off at the knees, while those with multiple SMSFs are given a fair warning.

Key take-out: SMSF trustees, accountants and advisers of all sizes will come under closer scrutiny.

The Taxman occasionally likes to remind us that he's no dummy. He knows what's goin' on, in the Big Brother sense.

In these times of big data, he's able to learn lots quite quickly. Further, if he notices a trend he doesn't like, he's able to press a few buttons to find out how many other suspects to put on his hitlist.

Sometimes, he might give a bit of a warning, when people are trying to be a little too smart.

Self-managed super funds were given some insights into the Australian Tax Office's headspace around what it thinks is goin' on recently. There are some trends the ATO isn’t liking and is looking into a little more closely.

This includes:

• Members trying to use multiple SMSFs to minimise or negate SMSF income tax.
• New SMSFs set up by those with questionable financial histories.
• An explosion in the use of reserves in the lead-up to the end of FY17.

There was more, including a suggestion for trustees to use “squeaky clean” advisers and accountants. It is not going to get too tough on errors around commuted market-linked pensions for now.

The top 100: A warning for Australia’s biggest SMSFs

There was also a stern warning for Australia's truly gigantic SMSFs. The largest 100 SMSFs in Australia are, by the sounds of it, all going to be reviewed individually by the ATO.

Undoubtedly, the top end of town’s SMSFs are incredibly complex, involving other trusts and incomes that simply aren't considered by most. The ATO will be looking deeply into some of those investments.

"Specifically, we will be looking at non-arm's length income, dividend stripping and structured tax arrangements designed to avoid tax," James O'Halloran, the ATO’s Deputy Commissioner Superannuation, told an accountants' forum.

"We will do this to ensure the money moving into the fund is taxed at the appropriate point and trustees are not gaining inappropriate access to concessional tax treatment unavailable outside the super environment."

Multiple SMSFs raise a red flag

In one "emerging issue" outlined by the ATO, the use of multiple SMSFs is raising a red flag.

The ATO says there are about 13,600 trustees who have more than one SMSF and 35 trustees who have "more than five SMSFs".

The main concern over multiple SMSFs is where trustees are trying to manipulate tax outcomes. This concern seems to be around switching the funds that are in pension phase in order to manipulate, particularly, capital gains tax.

For example, say you have two SMSFs, each with $1.6 million in funds, which would be based around the $1.6m Transfer Balance Cap (TBC). The first fund is in pension, while the second fund is in accumulation.

The assets of Fund #1 are sold with significant capital gains, and sold tax free. The trustee then moves the assets of this fund back into accumulation and turns the assets of Fund #2 from accumulation into pension, where they then sell further assets that have significant capital gains, also tax free.

Similar movements into and out of pension phase could also be decided around large inflows of income.

Under this strategy, there would technically be nothing to stop a trustee of multiple funds doing this with a third, fourth, fifth and sixth, and so on, SMSF.

Except that the ATO has extremely broad powers, when it comes to what it believes to be "tax avoidance" – and then you must prove it wrong.

Questionable histories of SMSF newbies

O'Halloran pinned some concerning figures to the set-up of new SMSFs, and how many never make it to the starting line.

Of the 26,000 new SMSF registrations received by the ATO in FY18, 2100 (9 per cent) were "taken off line" to be reviewed ahead of being given keys.

From that 2,100, 621 (29 per cent) had their ABNs withheld, and 336 (16 per cent) had their details withheld from the Super Fund Look Up, the latter of which means employers couldn't pay into the fund and super funds couldn't process rollovers to the SMSF.

How did the ATO come to make these decisions? Largely, by looking at three factors, which were:

• The financial history, behaviours and business acumen of the members and trustees
• The compliance records of their associated agents, administrators and other associated professionals
• Structural and set-up issues.

That means if you have a personally dodgy record with the ATO, it is going to question you being a trustee of a SMSF.

If the professionals assisting you with your SMSF (accountants, auditors, financial advisors) have less than stellar records, you will also be questioned.

And, if the SMSF is just set up incorrectly – by whatever means – then it will also come under scrutiny.

The ATO, when a flag is raised, will then check motivation factors around the set-up of the SMSF. O'Halloran says this also includes whether the trustees have considered if a SMSF would meet their short- and medium-term retirement goals, if they are aware of the costs of operating a SMSF and how these could impact their retirement funds, and whether they understand the overall obligations of running a SMSF.

Much of this actually comes back to the professionals who helped the trustees set up the fund.

The clients of the professionals that the ATO has concerns about will be scrutinised. But clients of even ‘good’ professionals need to make sure that a SMSF is the right vehicle for them. And further, they need to have considered their client’s reputation with the ATO and whether they would make a suitable trustee.

Sudden jump in use of 'reserves'

Reserves are used legitimately within a SMSF for many reasons, but the ATO is concerned about the jump in the use of reserves around the time of the implementation of the $1.6m TBC.

The ATO estimates there were 1,900 SMSFs with reserves in FY17, with funds totalling about $375,000, or an average of $192,000. Of that 1,900, 35 per cent had not previously reported reserves.

O'Halloran says the ATO will be looking at any unexplained increases in new reserves, increases in existing reserve accounts, or allocation of amounts from reserves into pensions.

"We will consider the potential application of the sole-purpose test … and Part VIA of the Income Tax Assessment Act,” says O’Halloran.

Fair warning. To avoid problems, trustees and their professionals must make sure their trust deeds allow for reserves, that there are investment strategies to deal with those reserves, and that it doesn't interfere with the fund's abilities to meet its funding requirements, when and as they fall due.

A final note: Trustee disqualification

And this – just in case you think the ATO isn't serious.

O'Halloran reminded the assembled accounting profession that 257 trustees, covering 169 funds, were disqualified during FY18.

Most of these disqualifications was due to concerns around illegal early release schemes and loans to members (70 per cent). But a further 64 trustees were disqualified for unrectified contraventions, 16 for taking part in dividend stripping, and a further five for non-lodgement of annual returns.

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 extremely complex and require high-level technical compliance.