Twenty trustee tips from the DIY tax man

PORTFOLIO POINT: If you’re running a SMSF, here’s some key things you must know – straight from the tax man in charge of self-managed funds.

This week I encountered a tax man who loved and understood self-managed funds and was even an investor himself. It was most encouraging and I am delighted to pass on this week his 20 suggestions to self-managed fund trustees plus his warnings as to where the tax people are going to be tough.

I encountered Stuart Forsyth at the annual meeting of the Association of Independent Retirees where I talked about my views on superannuation investment and other matters that most Eureka readers would be familiar with. But after the address I stayed around to listen to Stuart Forsyth, who has been a taxation officer since 1981. More importantly he is the tax man that for the last six or seven year has been in charge of self-managed funds. Forsyth decided to share with the retirees some of the requirements that the taxation Commissioner is looking at in terms of running self-managed funds. Most of the requirements and observations that Forsyth made were logical, but they were also interesting. While it was clear that Forsyth really understands self-managed funds, I must add that this is not the case with many areas of Treasury.

Forsyth pointed out that in 2011 self-managed funds achieved returns approximately equal to the APRA regulated funds. Both achieved returns of over 7%. In other words he was exploding the myth that the people who run self-managed funds don’t understand what they are doing, and they are doing well. They understand it very well and achieve their returns on much lower cost structures. Our self-managed fund movement is unique in the world and it works.

Forsyth also pointed out that some 900,000 Australian are involved as trustees of self-managed funds as trustees. Almost all of those trustees are beneficiaries of the funds. That is an enormous number of Australians and a great many of those self-managed funds are dedicated to providing pensions for beneficiaries. But now let me share with you the hints that Forsyth gave those operating self-managed funds.

1. His first hint was something I think I will go and do because it is a long time since I have actually done it: read the trust deed. My trust deed has been around for a long time and when it was started I certainly knew what was in it, but it has been a while since I took it out of the file.
2. Secondly, don’t overly focus on the Tax Acts, which are very complex. Your accountant can do that. Concentrate on what your trust deed requires and what is required to provide the benefits you are looking for.
3. Beware of having a self-managed fund where there is danger of marital disputes causing a split. Forsyth says he has seen many self-managed funds chewing up money in the courts as the beneficiaries fought over access to the money as part of a divorce/separation. I must add that I have seen this too and it is a weakness in the self-managed fund movement because if the trustees divorce from each other it can get ugly.
4. Forsyth pointed out that while your self-managed fund might be managed by you, it is not ‘your’ money. The fund is a separate entity. And if your fund no longer has a purpose it is much better to close it down than to have it lying dormant. Forsyth says some people find their self-managed fund does not suits their needs and they transfer the money to a large fund. Don’t let it lie dormant.
5. Self-managed funds rarely pay large amounts in tax because there is a strong investment in shares that give franking credits, and these franking credits offset the taxation. It’s a good example of how the managers of self-managed funds have made sure that their funds serve the needs they require. They will pay tax if it is required but if it can be legally minimised they will do it.
6. There is a clear trend for people to start paying pensions in the first year of a new self-managed fund. It other words when people retire they are switching their money from an industry fund or a large fund into their own self-managed fund. That fund immediately goes into pension phase and it doesn’t pay tax on its returns. A great many people have not used self-managed funds during their working life but are using them now they have retired.
7. In many cases actuarial certificates are required to determine distributions. Stuart Forsyth emphasised that these actuarial reports are very easy to obtain, either online or via your accountant and are not costly – $200 or $300 pays the bill.
8. Forsyth underlined many times about having income in a self-managed fund that is at arms-length from beneficiaries. If you transact with yourself there are dangers of severe penalties, which can decimate the money in the funds. There are less than 100 funds a year that deliberately did not comply with the tax laws and where there was clear evidence of deliberate avoidance. The penalties are harsh. Having said that, Forsyth emphasised that the Commissioner was only interested in prosecuting where there was clear evidence of intent to defraud the Act. If you make a simple mistake there may be a penalty but not a severe one. In most cases the “avoidance” is a deliberate act involving a large sum. The Commissioner has recently been to the Federal Court on three occasions to challenge the relationship between a self-managed fund and the personal affairs of a beneficiary, and on each occasion the Commissioner has won.
9. One of the lesser known provisions in the Superannuation Act is that where the beneficiaries die it is possible to have returned some of the tax payments that have been made. But on the death of the beneficiaries some self-managed funds do not have enough money in them to make that payment. If your fund is in that situation and, of course, if you discover it before death then it might pay to transfer to a professionally managed large fund that is able to distribute that tax. Advice is clearly required here.
10. About 74% of self-managed funds put their returns in on time. The self-managed funds are not required to file a return until some 11 months after the end of the financial year. As a result accountants tend to put them aside and only process them after almost all their other areas have been dealt with. Forsyth would like to see the process speeded up, but he realises that in doing that he is trying to reverse a fairly entrenched accounting practice. However he alerts self-managed funds that very often they have substantial credits that can only be distributed when the tax return is filed. Those credits would be available for investment or distribution much earlier if their accountants advanced the order in which they processed self-managed funds.
11. Forsyth and his people are planning to attack what he calls “intransient” funds – in particular those funds that have not lodged a return for the last three years. They should be wound up and the tax people are going to take a fairly tough line, as they should.
12. For the most part the changes to self-managed funds in the latest mini budget were not substantial. There were requirements that funds should gain an adequate return on investments. Consider insurance and value assets at market value. (Many people who had bought property for rental often have the property valued at cost rather than market.) The Commissioner normally does not require costly valuations each year but is looking for reasonable values to reflect true positions in funds.
13. Forsyth has alerted funds that he and his people will be looking at transfers of assets into superannuation funds and the price at which those transfers take place. The new rules covering transfers are going to be made much more regimented and it may be that some listed assets will need to be sold and then repurchased. The clear message was that if you are transferring assets into your superannuation fund (or transferring them out), make sure you have good advice.
14. Forsyth and his people have taken to phoning at least some people who start self-managed funds to make sure they know what is involved in running the fund and setting investment policies. There were some 36,000 new funds last year, or 800 a week. In some weeks the totals were much higher than the average, so only a small proportion of people are contacted. Forsyth believes that most people who start self-managed funds are genuine about it and know what they are doing, but of course there are some bad apples.
15. Make sure you lodge your return on time. He is going to get tougher in that area.
16. Where funding mistakes are made and the tax people require rectification, make sure that is done because the Commissioner is going to check.
17. Don’t loan money to members. It is a simple no no.
18. Consider how you are going to manage your fund as you get older, or what happens if the person who manages the fund dies leaving the other beneficiary to handle a fund without expertise. Many funds are run by the female in the relationship but often one party doesn’t fully understand what is happening. In my view if you are looking for a simple answer to this, go back to your accountant who will help the surviving ‘not fully informed’ spouse as to what to do. This is something that does need to be tackled, particularly as people get older. (Forsyth believes that there are going to be more professional trustee services available that are priced reasonably.
19. Forsyth believes that there are going to be more professional trustee services available that are priced reasonably. Look for them. Eureka will help.
20. Finally, and most importantly, be very careful of contributions. It is so easy to contribute more than the $25,000 that is allowable for tax deduction for older ages or even more than the $150,000 which is allowable per year on tax paid basis (you can also pay three years in advance with tax paid funds).

I found a number of those instructions to be very valuable. I hope you did too.