Duties and responsibilities of trustees

Everything you need to know about SMSF compliance.

Just as there are several levels of penalties that can be imposed for breaches of the regulations, there are different levels of responsibilities and duties for trustees of an SMSF.

It is also important to remember that, although the Australian Tax Office is the regulator and there are tax laws that must be complied with, there are also the regualtions in the SIS Act that govern the operation of a superannuation fund.

All trustees should be aware of the following:

The sole purpose test

 

In superannuation terms the top commandment is contained in a very lengthy section under the heading ‘Sole purpose test'. To see how the legislators set out this test in Section 62 of the SIS Act click here.

 

In simple terms the trustees of an SMSF should ensure all transactions have the sole purpose of providing retirement benefits to its members and/or their dependants after reaching a specified age (preservation/retirement age), after the death of a member or after a member becomes ill or injured. This benefit can be in the form of an income stream or a lump sum, as long as the fund's deed allows these types of benefits.

The final item of the section is what you would expect in any well-drafted legislation. This enables governments to allow for other ways that a person can access superannuation. Two recent examples of this are transition to retirement pensions and the terminal illness condition of release.

This sole purpose test should in fact make it easier for all trustees of an SMSF to make sure they do the right thing. If a trustee is thinking of taking an action that cannot be linked to providing a retirement or death benefit, it is more than likely not allowable. Members of a super fund are banned under this key principle from getting an immediate benefit from their superannuation.

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The trust deed

If the sole purpose test is the first commandment for trustees of an SMSF to follow, the trust deed of the SMSF is their bible. If trustees are ever unsure of whether they can do something, or they are not sure of how to do something, they should refer to the trust deed for guidance. This is the document that details all of their duties, responsibilities, and how the fund should be operated.

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Other duties and responsibilities

The other duties of trustees relate to the operation of an SMSF and deal with the main activities of the trustees of an SMSF. There are the duties and rules that relate to investing and the paying of benefits, and also those that deal with administration requirements.

These include keeping all relevant and required records and documents, such as minutes for ten years and accounting records for at least five years, plus lodging all required returns with the relevant authorities within the stated lodgement deadlines.

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Accepting contributions

Trustees have an obligation to only accept contributions from people entitled to make them within the limits laid down. These limits not only relate to the amounts that can be contributed but also to when they can be made.

The main restrictions on when a super fund can receive contributions are for people 65 and older. Once someone turns 65 they must satisfy the work test for contributions to be made on their behalf. Once a person turns 75 trustees of a super fund can receive no further contributions for that member, unless they are mandated employer super guarantee contributions.

The limits placed on the amounts received by a trustee on behalf of members cover (deductible) concessional contributions and (undeducted) non-concessional contributions.

These limits cover contributions made in cash and also those made in specie by transferring assets into a super fund.

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Section 62 Sole Purpose Test

Each trustee of a regulated superannuation fund must ensure that the fund is maintained solely:

(a) for one or more of the following purposes (the core purposes):

  • (i) the provision of benefits for each member of the fund on or after the member's retirement from any business, trade, profession, vocation, calling, occupation or employment in which the member was engaged (whether the member's retirement occurred before, or occurred after, the member joined the fund);
  • (ii) the provision of benefits for each member of the fund on or after the member's attainment of an age not less than the age specified in the regulations;
  • (iii) the provision of benefits for each member of the fund on or after whichever is the earlier of:

(A) the member's retirement from any business, trade, profession, vocation, calling, occupation or employment in which the member was engaged; or

(B) the member's attainment of an age not less than the age prescribed for the purposes of subparagraph (ii);

  • (iv) the provision of benefits in respect of each member of the fund on or after the member's death, if:

(A) the death occurred before the member's retirement from any business, trade, profession, vocation, calling, occupation or employment in which the member was engaged; and

(B) the benefits are provided to the member's legal personal representative, to any or all of the member's dependants, or to both;

  • (v) the provision of benefits in respect of each member of the fund on or after the member's death, if:

(A) the death occurred before the member attained the age prescribed for the purposes of subparagraph (ii); and

(B) the benefits are provided to the member's legal personal representative, to any or all of the member's dependants, or to both; or

(b) for one or more of the core purposes and for one or more of the following purposes (the ancillary purposes):

  • (i) the provision of benefits for each member of the fund on or after the termination of the member's employment with an employer who had, or any of whose associates had, at any time, contributed to the fund in relation to the member;
  • (ii) the provision of benefits for each member of the fund on or after the member's cessation of work, if the work was for gain or reward in any business, trade, profession, vocation, calling, occupation or employment in which the member was engaged and the cessation is on account of ill health (whether physical or mental);
  • (iii) the provision of benefits in respect of each member of the fund on or after the member's death, if:

(A) the death occurred after the member's retirement from any business, trade, profession, vocation, calling, occupation or employment in which the member was engaged (whether the member's retirement occurred before, or occurred after, the member joined the fund); and

(B) the benefits are provided to the member's legal personal representative, to any or all of the member's dependants, or to both;

  • (iv) the provision of benefits in respect of each member of the fund on or after the member's death, if:

(A) the death occurred after the member attained the age prescribed for the purposes of subparagraph (a)(ii); and

(B) the benefits are provided to the member's legal personal representative, to any or all of the member's dependants, or to both;

  • (v) the provision of such other benefits as the Regulator approves in writing.

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Investing

The restrictions on the investing activities of the trustees of SMSFs are the most numerous. This is because this is the area where most breaches can occur.

Trustees must take account of the following regulations when it comes to investing:

Investment Strategy

Trustees of an SMSF must have an investment strategy in writing. It can be very general, such as stating broad limits on the different investment sectors the trustees can invest in, or it can be very specific.

The main thing to understand is that the investment activities of the super fund must be able to be measured against and done in accordance with the strategy.

As a minimum the strategy should take account of the risk associated with an investment's return. The strategy should also consider the activities of the SMSF and the point that the members are at.

In other words, the strategy must ensure there is sufficient liquidity in the investments to be able to pay all commitments, including tax, administration costs and benefits. As a part of this, trustees should take into account the importance of diversifying the SMSF's investments over the various types of investments.

The investment policy regulations were updated in August 2012 so that the investment policy must be reviewed regularly. Many experts believe that this condition will be met if the investment policy is reviewed annually, or at other key times such as when a member is admitted to a fund or a pension is commenced. In addition the changes make it compulsory for trustees to consider the requirement of insurance for members.

Investments must be made and maintained at arm's-length
In most cases this requirement is not a problem as they are purchased from totally independent parties. Where investments are purchased from members this must be done on commercial and arm's-length terms. In the limited circumstances that an investment is allowed to be used by a related party, such as commercial property, commercial rentals must be paid.

This duty also requires trustees to keep the SMSF's assets separate from their own. In addition the assets of the SMSF must show the trustee or trustee's names on the ownership documents and preferably also the name of the SMSF.

Investments cannot be purchased from related parties except in limited cases
The only exceptions to an SMSF purchasing investments from members are when they are publicly listed such as shares, widely held trusts such as unlisted property trusts, or when it is business real estate such as shops or offices. The only other exception is investments purchased under the 5 per cent in-house assets rule.

In-house assets cannot exceed 5 per cent of the market value of the fund
Where investments, loans or other financial transactions involve members or related parties, their total value cannot exceed 5 per cent of the total value of the SMSF. The values used for this test are the current market values and not the purchase costs. These investments are called ‘in-house assets'.
​Examples of in-house assets include:

  • monies lent to related parties through a private company,
  • a car owned by the SMSF leased to a member or related party,
  • property owned by the SMSF leased to members or related party,
  • artworks and other collectibles owned by the SMSF and kept in a member's home.

In all of these cases of in-house assets their combined total cannot exceed 5 per cent of the total market value of the SMSF. This means in most cases only SMSFs with very large member balances and total asset values can look at using the in-house assets rules.

Investments must be valued at market value
Trustees of SMSFs must value the investments of the fund at market value each year. To help trustees of SMSFs with valuing investments the Tax Office have issued an information sheet " Market valuation for tax purposes" that provides guidance for SMSFs.

For many investments made by SMSFs there will be markets in place and establishing a value will be relatively easy. Listed shares can use the value shown on the last trading day of the financial year supported by published share tables. For managed funds the annual statement showing the value can be used.

The requirement to value investments at market value does not mean all investments must be valued by a valuer. In fact collectables and personal-use assets are the only investments that must be valued by a qualified independent valuer.

Where a property is owned by an SMSF the ATO does not even require a formal valuation by a registered valuer. Instead, in its information sheet the ATO states, ''the valuation may be undertaken by anyone as long it is based on objective and supportable data''.

The Tax Office even goes further by outlining the relevant factors and considerations to be considered in arriving at a market value. These include:

  • The value of similar properties.
  • The amount paid for a property in an arm's-length transaction.
  • Appraisals by an independent person.
  • The cost of improvements since the property was last valued.
  • Using net income yields for commercial properties.

In this situation the trustees must be able to provide evidence of the valuation process, such as a real estate agents appraisal, so the auditor of the fund can accept the value used.

The Tax Office is also taking a practical approach to how often a property needs to be valued. Unless there is an event that has affected the property since it was last valued, such as a big change in market conditions or a natural disaster, the property does not need to be valued each year.

The exceptions to this are where the fund's trust deed requires annual asset valuations and where a fund has any pension members. In these cases all assets need to be appraised each year.

In the absence of these events, it is generally accepted a property only needs to be revalued every three years. It would be wise, however, for trustees to state as a part of the fund's annual investment strategy, that in their opinion the value of properties had not materially increased since they were last valued.

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Keeping funds separate

The trustees of an SMSF must keep the cash and investments of the fund separate from their own personal assets and any assets belonging to other entities or businesses they are associated with. This means a super fund must have bank accounts and investments that are not used for any purpose other than the activities of the SMSF.

To assist in satisfying this requirement trustees should ensure bank accounts, trading accounts and all asset acquisitions are noted as being acquired by the fund. This is extremely important where property is purchased and the titles office does not allow the super fund's name to be noted on the title.

This duty is one that, despite the best intentions of the trustees of an SMSF, is often breached. This can be as a result of a trustee accidentally banking cash or cheques meant for the super fund into a private account, or it can be as a result of a mistake by an investment manager or bank crediting a deposit to a wrong account. When these mistakes are made and discovered they must be corrected as soon as possible.

As all of the investments in an SMSF must be in the name of the trustees as trustees of the fund, where the trustees are individuals it can be easy for mistakes to be made. One way of reducing the chance of this duty being breached is to have a company formed to act as trustee for the SMSF.

This does cost more in the setup stage of an SMSF but, where the company trustee name is very different from the names of the members, it reduces substantially the chance of this duty being innocently breached. It also means that when one on the members dies by having a company act as trustee the SMSF continues.

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Payment of benefits

Where an SMSF's deed is silent on when benefits must be paid out there is only one situation where trustees are forced to pay benefits, and that is when a member dies. When this occurs the trustee must, as soon as practicable after the date probate is granted, pay out the deceased member's benefits. In most cases these can be paid to a member's estate or dependants.

Just because a member dies does not mean their benefits must be paid out. Where they are receiving a reversionary pension, and the reversionary pensioner is a dependant, no lump sum payment is made as the pension is paid to the reversionary pensioner. Trustees of an SMSF can also decide to pay death benefits to a dependant in the form of a death benefit pension.

For all voluntary cashing of benefits, in other words benefits requested to be paid by a member, depending on the type of benefit a condition of release must be met.

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No financial assistance to members

Members of an SMSF, and/or their relatives, are unable to receive loans or other financial assistance from the fund. This ban also stops an SMSF allowing its investments to be used as security for a loan to a member or a member's relatives.

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Super funds and borrowing

As a general rule super funds are not allowed to borrow. The only times they can are:

  • to pay any surcharge obligations the fund may have, provided the fund uses any cash reserves first, and provided the debt is less 10 per cent of the total assets of the fund, and is only maintained for a period of up to 90 days
  • to pay out benefits to a member if the loan is not for longer than 90 days and it does not exceed 10 per cent of the market value of the super fund, and there are no other cash assets of the fund to make the benefit payment
  • after exhausting the cash in the fund to pay for an investment, if the fund is experiencing unexpected short-term cash flow problems and the loan is not for longer than seven days and does not exceed 10 per cent of the market value of the super fund, a loan to pay for an investment after it was purchased
  • when a super fund meets the conditions set out in the Act relating to limited recourse borrowing arrangements.

At the heart of the rule is the necessity to protect the members' funds from attack. Without this rule, members of SMSFs and also large industry and commercial funds, would face the risk of their retirement savings being wiped out by unwise borrowings.

Before the law changed on 24 September 2007, super funds could invest in managed funds that had borrowings. In this case the only thing at risk was the investment rather than the entire super fund.

The new legislation that applied from September 2007 did not change the long-term rule that prohibits super funds from borrowing. It did however introduce an exception to this rule under the following very tight conditions:

  • The borrowing must be related to the purchase of an asset that the trustee of the super fund is allowed to purchase.
  • The asset acquired is to be held on trust so that the fund receives a beneficial interest in the asset.
  • The legal ownership of the asset can pass to the super fund after it has made one or more payments or instalments.
  • The loan taken out by the trustee of the super fund must be a non-recourse loan, which means the lender only has a claim on the asset purchased and not the other assets of the super fund.

First Condition
Means that the asset purchased must fit within the investment strategy of the super fund and it cannot be one that is prohibited by law. For example, this amendment does not alter the fact that, except for a few limited exceptions such as business property, a super fund cannot buy assets from members.

Thus this ability to borrow does not mean a super fund can borrow to purchase a residential property from a member, but it does mean a super fund can borrow to purchase a business property from a member or a residential property from a non-associated entity or individual.

Second Condition
Requires the asset purchased with borrowings to be held by a custodian. This borrowing or instalment trust requires a trustee, preferably a company, to be shown as the legal owner of the asset with the super fund being the ultimate beneficial owner.

Third Condition
Requires the super fund to make one or more payments before it can become the legal owner of the asset. In practice what this means is that a trust must be formed which purchases the asset. Once all payments have been made by the super fund it becomes the legal owner of the asset.

Final Condition
For the borrowing to be a non-recourse loan — this means that, unlike other loans where lenders require guarantees from everybody associated with the borrowing, the super fund cannot be at risk if there is a default on the loan. Ultimately this means the financial institution advancing the funds can only use the asset purchased as security for the loan. Any guarantees provided by members to assist with the loan being approved, must also be limited to the asset the fund is acquiring with the debt.

Warnings

ASIC has repeatedly expressed concerns over the number of SMSFs investing in residential real estate. In many cases developers of the residential real estate, and or their commission driven sales people, are getting people with very little super to set up an SMSF so they could sell their properties. If someone suggests setting up an SMSF just to buy a property get independent professional advice before doing anything.

Trustees of self-managed super funds should be very careful before buying assets under this exemption. Since the introduction of the new legislation a new industry has grown up offering documentation services and funding to super funds. The old legal tenet of ‘let the buyer beware' is applicable.

Costs quoted for drawing up the required documentation range from as little as $125 to more than $5,000. Before deciding on who you will get to prepare the documentation, you should check with the financial institution providing the funds. It will be them that decides what sort of warrant trust is needed.

In addition, the interest rates payable on non-recourse loans can range from a very reasonable rate up to what could be classed as almost loan-shark rates. Some providers of finance for geared property purchases offer a bundled product that includes the finance and the documentation.

In these cases trustees can find they are not only paying an exorbitantly high interest rate but paying more than they need to for the documentation. When the service is being offered by a developer they can also pay an inflated price for the property. Trustees will need to do their homework, compare what is available and use the borrowing capacity wisely.

Trustees should also exercise caution when it comes to the amount being borrowed to purchase the asset. Unless they are happy to pay inflated interest rates, trustees of a super fund should limit the borrowing to no more than 60 per cent of the cost of the asset purchased. By limiting the borrowing the super fund will also have a reduced risk of being put under financial pressure if asset values and incomes reduce.

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