The Australian

Samantha Bailey, Business Reporter

18 December 2018

Super members are on track for their first annual loss in seven years, following two
months of declines as market volatility continues to test global markets.

According to superannuation research company SuperRatings, super members
invested in the median balanced option made a negative return of 0.6 per cent in
November, following a 3.1 per cent decline in October.

Ongoing market weakness in December is likely to erode what’s left of the gains held
in median balanced funds by the end of the calendar year, which at the moment are
sitting on a return of about 1.8 per cent, SuperRatings said.

That is before investment fees, tax and implicit asset-based administration fees.
Super members who are only exposed to Australian equities suffered a worse decline
in November of 2.4 per cent, pushing them into negative territory for the year to date.

The local sharemarket is currently down almost 10 per cent for the December quarter,
in what is shaping up to be the worst December quarter since 2008.
The benchmark S&P/ASX 200 is currently down 7.8 per cent for the 2018 calendar
year.

Recent declines come on the back of concerns about slower global growth, which have
rocked already jittery markets.

Globally, markets were already volatile amid simmering trade tensions between China
and the US intensified after the CFO of Chinese telco giant Huawei was arrested
earlier this month at the request of the US government for alleged violations of Iranian
sanctions.

The last time super members experienced an annual loss was in 2011 when the median
balanced option returned a negative 1.9 per cent.
Super members with exposure to only Australian equities suffered declines of 9.6 per
cent that year.

SuperRatings estimates that between 60 and 70 per cent of Australians with their super
held in a major fund are invested in the default investment option, which in most cases
is the balanced investment option.

“Heading into 2019, it looks like members will need to get used to some of the
volatility we’ve seen in markets over the past two or three months,” said SuperRatings
executive director Kirby Rappell. “This is certainly a challenging environment for super funds at the moment.
“Share markets are under pressure globally, and recent data indicate that the economy
is weaker than expected, with downside risks including a softening housing market
having a real impact on confidence.”

Still, SuperRatings said members remain ahead over a 10-year period, with $100,000
invested in the median balanced option in November 2008 now worth $206,366.

Despite a volatile 2018, $100,000 invested in the median Australian Shares option in
2008 is now worth $230,482.

At about 11.15am (AEDT), the ASX 200 was trading down 1.2 per cent.

Samantha Bailey, Business Reporter

The Australian

James Kirby, Wealth Editor

18 December 2018

Big super funds which have been coasting on an extended post-GFC recovery are set
to be tested in the months ahead with much poorer returns looking likely this financial
year.

As super fund members have come to expect returns of 9 per cent plus per annum, this
year looks very different. If the books for the financial year were ruled off just now the
average balanced super fund would present a lower-than-inflation return of 1.8 per
cent (annualised inflation is running at 1.9 per cent.

All superfund managers would be well aware the last few years have been
exceptionally strong — after all the long term average for super funds is a modest 5.6
per cent per annum. But that will not make it any easier for big funds when explaining
to fund members why their annual contributions have been made into a sinking
market.

The poor numbers — which look like the worst since 2011 — will create different
tests for different fund formats. Industry funds, which have more unlisted assets, will
have new liquidity strains if members seek to take money out. Retail funds, from
banks and insurers, will be particularly exposed to an unfortunate combination of
losses in both the share market and the bond market. Separately, Self Managed
Superannuation Funds (SMSFs), which are traditionally overweight in cash and
Australian shares, will get support from cash holdings while share holdings will
almost certainly create a drag on returns.

The very poor first half of FY19 was confirmed by two leading researchers Chant West and SuperRatings. Ominously the SuperRatings report for November suggested:
“Ongoing market weakness in December is likely to eat away at what is left of super’s
gains through 2018”. While Chant West research manager Mano Mohankumar warned
“the flat result doesn’t come as a surprise given the stellar run super funds have
experienced since 2009.”

The most recent losses among super funds has been driven primarily by sinking share
markets. Though returns on Wall Street have regularly been better than the ASX, a
rising Australian dollar in the month of November created a negative result for
Australian investors in unhedged terms. Listed property investments, which can
smooth out broader share market volatility, did not help much either over the last few
weeks — Chant West says Australian-based property trusts were down in the most
recent period.

The majority of workers in Australia are in balanced funds, while a smaller number of
younger or less conservative investors opt for so-called growth funds which take on
more risk with the promise of higher rewards. Mohankumar at Chant West suggests
“with just two weeks of the year remaining, growth funds still have a chance of
finishing in the black.”

Growth funds have seen asset prices sinking fast in recent weeks, but a very strong
performance from shares earlier in the year could buoy the final numbers. As
SuperRatings numbers show despite suffering heavy losses in October (-5.8 per cent)
and smaller losses in November (-0.4 per cent) members invested in the median
international equities option have experienced returns year to date of 2.1 per cent.

The last time super members were hit with a negative year — in 2011 — the median
balanced option returned -1.9 for the year, while growth options were hit hard, median
Australian equities option dropped 9.6 per cent and international equities option fell by
6.7 per cent over the full year.

James Kirby, Wealth Editor

The Australian

James Kirby, Wealth Editor

15 December 2018

A staggering $45 billion worth of franking credits are being hoarded by some of
Australia’s biggest companies and demands to release them before an ALP
government comes to power are rising fast.

New research on some of our biggest stocks reveals companies such as Rio, Fortescue
and Caltex have a treasure trove of stored up franking credits. In an extreme example,
Harvey Norman’s franking credits are equal to 14 per cent of the retailer’s $3.7bn
market value.

But these credits will be useless to a significant shareholder segment if the ALP wins
the next election, as the opposition plans to scrap the cash rebates retiree investors
receive on franking credits despite franked shares making up the backbone of most
small shareholder portfolios.

“If franking credit was a listed company, it would rank as the seventh biggest company
in Australia,” says Hasan Tevfik, a senior analyst at MST Marquee who has run the
numbers on the ASX. Tevfik’s research shows major companies are hanging onto
franking credits when there appears to be very little reason to do so.

JB Hi-Fi, Woodside, Woolworths and Flight Centre — all favourites with retail
shareholders — also appear high on the list that has been compiled excluding financial
stocks since banks generally distribute all their franking credits on a regular basis.

BHP and Rio have already made some effort to release their excess franking credits but the report shows that, even including their planned measures, they still have franking credits that are relatively high — representing about 7.4 per cent of the market capitalisation at BHP and 10.3 per cent at Rio.

In an ideal world, listed companies would have little or no franking credits stacked up
on the balance sheet but, citing conservatism, many blue-chip groups use them as a
buffer to be used in tough times.

The problem now is such conservatism could carry a high cost that will be shouldered
by older investors if the ALP goes ahead with its controversial plans. Opposition
Treasury spokesman Chris Bowen has repeatedly said he will not budge on the issue.

Typically, companies can get the franking credit value off their books and into small
shareholders’ pockets through special dividends or buy-back programs.

The new research follows a similar exercise a year ago by Macquarie Bank. That
report, based on results in the year to June 2017, showed the worst companies in terms
of franking credits had been Salmat, The Reject Shop, New Hope Corporation,
Cabcharge and BHP.

Macquarie Bank has been collecting franking credit data for more than a decade as
investors have always kept an eye on credit balances to ensure capital management
was optimised.

Analysts argue that companies with franking credits banked up on their books may not
be acting in the best interest of shareholders if they resist actively distributing those
credits.

“We know some of these companies have resisted and boards have waved off
questioning shareholders … but we find the excuses poor,” says Tevfik. “The ALP policy will make franking credits worth less to the aggregate shareholder.”

Under existing arrangements, the vast majority of retirees are tax free. When
Australian companies pay dividends they have franking credits attached — the system
was originally introduced by the Labor government. Shareholders who have tax bills
can offset their franking credits from their annual tax.

However, retiree shareholders — who are tax free — don’t have a tax bill to offset. To solve this issue, the Howard government introduced a rebate plan where retirees could
get a cash cheque in lieu of their shareholder rights in relation to franking.

The ALP opposition has proposed scrapping this arrangement with no compensation
— retirees who are on pensions or part-pensions are exempt.

It is estimated the average retiree investor gets about $6000 a year in franking credits.
In recent weeks the issue has become a key area of political debate as fund managers
led by Wilson Asset Management’s Geoff Wilson protest against the scheme.

Opponents suggest the plan is discriminatory as it isolates a specific section of the
community — older independent investors — on a tax measure.

Wilson, who raised a petition against the change, believes the ALP measure is
essentially unfair and penalises investors who have constructed their portfolios on
what many had taken to be a settled government policy.

Earlier this year he suggested: “What disturbs me is that I don’t think people
understand how crippling these changes will be to people who have abided by all the
laws for the last 20 years.”

The debate has been inflamed by union-backed industry super funds suggesting they
would not be affected by the measure.

This is because franking credits are not being terminated — rather, it is the right of
independent retirees to receive cash for those credits that is being terminated. As a
result, most large-scale funds — industry or retail — will not be affected since they
can still use the franking credit offsets.

With $45bn worth of credits yet to be distributed, time is running out for the biggest
hoarders.

James Kirby, Wealth Editor

The Australian

Joe Kelly, Political Reporter and Paige Taylor WA Bureau Chief

11 December 2018

Labor MPs believe turmoil in the Coalition is masking widespread dismay and anger
among older voters over the plan to introduce what critics call a “retiree tax”.

“It’s quite polarised,” a Labor MP said yesterday. “You get reaction from self-funded
retirees who say, ‘we pay the household expenses out of that cash refund and we’ve
looked after ourselves for years’. There’s a little bit of that”.

A special Newspoll conducted for The Australian bears out Labor’s internal concerns over how the policy has been received. Support for the $55.7 billion plan to scrap the
refundable tax credits on shares has fallen three percentage points since March, while
almost half of those surveyed, 48 per cent, were opposed.

An age breakdown reveals the over-65 bracket is most strongly opposed to the ALP’s
plan, with 62 per cent of voters in that demographic registering their disapproval of the
Labor policy.

Under the commitment, only pensioners and other recipients of government
allowances (such as the carer payment or parenting payment) will still receive the cash
refunds after Bill Shorten modified the plan earlier this year, following a backlash led
by retiree groups. But the policy tweaks won’t help John and Jan Bain, who today
officially join the nation’s grey army of 1.1 million self-funded retirees. Mrs Bain, 74,
will today work her last shift as a physiotherapist in their home town of Bunbury,
170km south of Perth, while husband John, 72, left his job as a livestock agent 14
years ago after a stroke, then relied on sound money advice to maintain the couple’s
finances on the long road back to good health.

“It’s still a fairly slippery slope that we are walking on moneywise, but I think that’s
true for a lot of self-funded retirees,” Mr Bain said yesterday. “The rules have got so bloody complicated.”

Once aligned to the Liberal Party, Mr Bain describes himself as a “drifting” rather than
a swinging voter these days. He said he was appalled by the recent chaos in the
Coalition and was unsure who to vote for at next year’s election, but felt he could not
support Labor’s cuts to the refundable tax credits on shares because it would punish
“middle Australia”.

“We think that if this gets in it will end up costing us somewhere between $10,000 and
$12,000 a year, somewhere around there,” Mr Bain said. “We have got a very good
financial adviser … but we are not rich.”

Only 46 per cent of Labor voters agree with the plan, while approval drops to just 15
per cent among Coalition supporters. Total support is running at 30 per cent, down
from 33 per cent in March when the last Newspoll on the issue was conducted.

Opposition to the policy has also dropped from 50 per cent to 48 per cent while the
number of voters undecided on the shake-up has lifted from 17 to 22 per cent. Among
Coalition voters, opposition is running at 71 per cent compared with 33 per cent for
Labor supporters.

The refunding of franking credits was a system implemented in the Howard
government’s 2001 budget, allowing super funds and individuals to receive cash
payments if their dividend imputation credits exceeded their total tax liabilities.

Estimates suggest about 33 per cent of cash refunds go to individuals, 60 per cent to
self-managed super funds and about 7 per cent to APRA-regulated funds.

The Labor policy was framed as a way to close down a “tax loophole that mainly
benefits millionaires”. Opposition Treasury spokesman Chris Bowen warned that the
cost of refunding the dividend imputation credits had become unsustainable.

The cost of the concession has ballooned from about $550 million when the measure
was introduced by former Liberal treasurer Peter Costello — when the budget was in
surplus — to more than $5bn a year. Labor’s policy would raise $55.7bn over a decade
from July next year if Mr Shorten wins the next election.

The self-managed super fund sector and seniors groups have warned the Labor policy
will bring about a number of unintended consequences while continuing to benefit the wealthy who have enough tax liabilities to exhaust the full value of their franking
credits.

Dividend imputation was introduced in Australia in 1987 to avoid double taxation of
company dividends. It provides a tax credit to shareholders for tax already paid by the
company on their behalf. In a submission to the parliamentary standing committee on
economics, which is conducting an inquiry into the removal of refundable franking
credits, Michael Rice, the chief executive of actuarial firm Rice Warner, warned that
there would be behavioural changes arising from the Labor policy.

“The main groups affected would be retirees on modest incomes holding equities
directly and many SMSFs which have assets predominantly in pension accounts,” Mr
Rice said.

He suggested these groups would shift their assets out of Australian equities, attain
higher yields in other assets such as overseas-listed shares or infrastructure trusts or
move their assets into unfranked Australian equities.

He suggested that some self-funded retirees would increase drawdowns from their
superannuation to preserve their current levels of income, resulting in more people
receiving the age pension earlier in life — an outcome that would impose additional
costs on the government.

One consequence could see more people closing their SMSF and moving their assets
into an APRA-regulated fund where their franking credits could be offset against other
taxable income within the fund.

The Australian

James Gerrard

1 December  2018

Earlier this week, the man who may be our next treasurer, Chris Bowen, reiterated the
ALP was not interested in amending its plans to scrap cash rebates for franking credits
— a key element of income for many retirees.

The crux of the issue is that retirees, who in good conscience saved money in super,
are having the rug pulled from under them. They are being treated as companies,
effectively being taxed at 30 per cent on part of their income, with their tax-exempt
super status being ignored.

I am going to run through several scenarios that would allow an investor to sidestep
the franking credit plan, but first it does need to be put in perspective. The Labor
Party’s plans to make a retrospective change to super not only adversely affects about
one million retirees who are not eligible for a part or full age pension, but also
undermines the confidence in the system.

Why would the younger generation bother trying to save for retirement by way of
extra super contributions when governments (both Coalition and Labor) make taxgrabbing
changes that are backward looking?

The result? Less money saved by Australians for retirement and a heavier reliance on
the public purse.

Geoff Wilson, founder of Wilson Asset Management, says: “This is bad policy. What
Labor doesn’t understand is that all Australians are intelligent. They will adjust their
finances to minimise the impact of this money grab from Labor. The $5 billion-plus
Labor talk about raising per year is discriminatory, unfair and illogical. The money they believe they will raise is a mirage.”

Wilson is best known among investors for a string of listed investment companies
such as WAM Capital and WAM Leaders fund. In common with other LICs such as
AFIC and Argo, Wilson will face a dilemma if the new rules become reality — the
LICs will lose out as investors steer away from products where the franking credit
attractions have been removed for retired investors.

Indeed, Wilson said he would be forced to convert all his group’s LICs to unit trusts if
the ALP win, and other LICs would no doubt do the same creating legal costs for
every LIC in the market.

As professionals such as Wilson think the issue through, the biggest problem is that
not all retirees will make the right decision when these changes arrive and some will
expose themselves to riskier investments chasing unfranked dividends. Timing is also
an issue. With the royal commission putting a dampener on bank share prices, anyone
thinking of bailing out of fully franked bank shares to unfranked investments will lock
in a loss of 10 per cent over the past 12 months.

For the people thinking about what they can do to counteract the impact of the policy,
here are three potential workarounds:

1. If you don’t want to lose your exposure to fully franked blue-chip shares such as the
banks, BHP and Wesfarmers, one option is to sell the shares the day before they
declare their dividend, known as the ex-dividend date. You then buy the stock back the
next day after the share price falls. The problem with this approach is that the share
price usually falls by the cash dividend amount alone, not by the total value of the cash
dividend and franking credits.

2. An alternative strategy that is gaining traction with retirees is to move into listed
property investments via real estate investment trusts, which are seen by many as the
closest comparable investment to fully franked bank shares. REITS are property trust
structures that trade on the ASX. Unlike normal shares on the ASX, REITS do not
withhold tax as all distributions are taxed in the hand of the investor.

3. For the more passive investor, there are several ETFs that can invest in unfranked
investments such as Betashares Legg Mason Real Income Fund that holds a portfolio
of largely unfranked property, utilities and infrastructure assets While it is still too early to panic, the writing is on the wall with regard to the scrapping of cash refunds on excess imputation credits.

James Gerrard is the principal and director of financial planning firm
FinancialAdvisor.com.au.

The Australian

Robert Gottliebsen, Business Columnist

29 November 2018

I am very grateful to Chris Bowen, the shadow treasurer, and very likely the next
Australian treasurer, for opening up the debate on his dividend imputation proposals.

His comments are on The Australian ’s web site and were published in the print
edition of November 29. I urge my readers to look closely at the Bowen letter.
As I respond I want to ignore the emotive comments but separate the issues into clear
compartments.

First, I want to emphasise that I am an admirer of Chris Bowen, because he has had
the honesty to say what he plans to do well in advance of the election, so debates like
this one can be held outside the pressure cooker of an election campaign.

Second, I think a debate about dividend imputation is both healthy and well overdue.
The objection I raised in my commentary earlier this week was not about changing
imputation but rather the way it was being done.

Thirdly, I agree with Chris Bowen that on the basis of current figures available there is
a pile of money to be raised from rich people using his proposal.

My argument is that since those figures were compiled there have been changes to
taxation and rich people are flexible so they will escape the blows. My knowledge of
this comes because I mix with people and advisers who are just laughing at Bowen’s
proposals. This is a tax on battlers.

We can argue over who will be affected for ever and it is not until the legislation is in
operation that the winner of the debates will be known. There are bigger issues in this
tax so I pulled back and left it that we should agree to disagree to enable the debate to
be concentrated on the fundamental issues.

And these issues are so important that I want readers for the moment to theoretically
agree with Chris Bowen that the receipt of cash franking credits should be blocked.

It’s only when you look only at how the “ban” on cash imputation payments is being
executed that you see clearly that Chris Bowen has adopted unfair methodology.

So, ignoring our views on imputation, let’s sit down and look at what we should do to
block the receipt of cash franking credit refunds.

The first pillar that former Labor prime ministers would require is that the ban on cash
franking credits should apply to everyone, unless there is a clearly stated exemption
for, say, government pensioners.

And again the exemption should apply to all government pensioners, not just a
selected group. My objection to the Bowen plan is that it fails these basic fairness tests
that the former Labor prime ministers would have applied.

My sadness is that Chris Bowen in his letter did not address these fundamental criteria.
Instead it was all about attacking me. I have no problem being attacked but the
attacker must also address the issues.

And the fundamental issue is that a huge section of the non-government pensioner
Australian population will continue to receive their cash franking credits in full as they
currently do simply on the basis of the fund manager they have selected.

Once we decide that cash franking credits should be banned it is grossly unfair to
divide the population on the basis of who they choose to manage their money.

If my savings are in the superannuation system in pension mode and I want to
continue to receive my cash franking credits, all I have to do is transfer my money
from my current large fund that is caught or from my self-managed fund to an industry
fund (or big retail fund).

My money stays in superannuation and simply by changing fund manager I continue
to receive all my cash franking credits. And the industry funds have been performing
well so I am not being penalised on the fund return comparison.
There is no way such legislation can be fair. How are the industry fund managers able
to continue to provide my cash franking credits while other managers can’t do it?
The industry funds have a vast army of Australian members who are wage and salary
earners whose superannuation is not in pension mode.
The industry and big retail funds “sponge” on those workers by using the tax they pay
to offset against the retirees’ non-tax status.
The fund manger is able to net off two entirely separate tax situations. If my money
happens to be in a fund that does not have enough salaried workers then I lose my
franking credits.

This is blatant discrimination so it would seem there is clearly another agenda. I won’t
spell out what agenda might be but readers can make a fair guess.

If Chris Bowen’s only agenda was to stop the payment of cash franking credits then
everyone who receives them must lose them. Then it’s a fair tax.

That still leaves the government with the ability to legitimately exclude those on the
government pension—they can still receive their franking credit entitlement in cash.

But again, under the Bowen plan there is discrimination —-a portion of government
pensioners miss out because those in self-managed funds discover there is cut off date,
March 28. All those in self-managed funds who became entitled to the government
pension after that date do not receive their cash franking credit entitlement.

When you tell the population that they can continue to receive cash franking credits by
changing fund managers or being born on the right date then clearly cash franking
credits aren’t your only target.

If the key agenda is to concentrate superannuation in a few hands then be bold and say
that upfront rather, than using cash franking credits as a smokescreen.

And the real debate should be about the total issue of franking credits.

Again, as treasurer of Australia, if you believe the system is too generous then be open
about it and tell Australians your view and we will debate it.

Maybe we will then reduce the franking credit entitlement from 100 per cent to, say,
95 per cent.

Then everyone pays and the tax is not just levied on a select group of people who
happen have saved outside industry superannuation funds.

ROBERT GOTTLIEBSEN, BUSINESS COLUMNIST

The Australian

James Gerrard

24 November 2018

If the ALP comes to power and delivers on its threat to scrap cash rebates on franking
credits, what could you do?

An investor might reframe the question in this manner: is it better to take drastic action
and sell down all self-managed superannuation fund assets, transferring the wealth to
the investor personally and in so doing remove the cost, administration and trustee
responsibilities attached to running a SMSF?

After the public uproar that resulted from the initial policy announcement, Labor
revised its proposal to allow SMSFs with at least one member receiving a Centrelink
pension or allowance as at March 28, 2018 to continue to be eligible for cash refunds
of excess franking credits. The outstanding problem with the policy proposal is that it
discriminates against people in the middle. People with low income and assets are
exempted and people with significant assets in super are only partially affected.

The reason the rich continue to benefit is that with the relatively recent balance
transfer caps, only $1.6 million can be held in a tax-free super pension per person.

For those with money in super above $1.6m, the excess needs to be held in the super
accumulation account, taxed at up to 15 per cent on income and gains.
In other words, because the ultra rich will still have significant funds in the super
accumulation account that attracts 15 per cent tax, they will continue to use franking
credits to reduce tax on the accumulation account, and therefore may be largely
unaffected by the policy change.

But it is the people in the middle who are hardest hit, deemed too wealthy to receive
Centrelink benefits, but not wealthy enough to have more than $1.6m in super. They
feel the full force of the Labor imputation credit changes.

For the $1m SMSF with a retired homeowner couple as trustees and members, they’re
over the threshold of $848,000 to receive a part age pension, and thus targeted by the
Labor policy proposal. If they held 25 per cent of the super fund in fully franked
shares paying an average 6 per cent dividend, that equates to franking credits of about
$6500 a year at risk of being lost.

Some SMSF trustees may cop it on the chin, while others may close the SMSF and
deal with the money outside super. (This example is typical; the average cash refund
cheque is close to $6000).

Exploring that path in more detail, if the investments are transferred out of super into a
joint personal investment account and generate an average income return of 6 per cent,
with 25 per cent of the income being from fully franked dividends, that equals
grossed-up taxable income of $66,428 including $6428 of franking credits.

If each spouse is allocated half of the income, $33,214 per spouse, tax payable is
$2872. After franking credits are applied, there is no tax payable, with $342 in
franking credits still to spare.

The big drawback to this approach is that you’re now exposed to capital gains tax
personally. So it depends on how you manage your investments as to whether this
approach works for you.

If there is moderate turnover of the portfolio with gains being realised each year, not
only will your investment income be taxed, but you may end up with a large tax bill
due to realised capital gains.

Another consideration is that the policy may change over time. Labor may further
water down the policy or even reverse it.
If it works out best to hold money inside super in future, irreversible damage would
have been done by those who shunted money out of super, which, due to a
combination of contribution caps and work tests for those over 65, makes it extremely
difficult for people to get money back in super down the track.

And it doesn’t stop there. Estate planning also needs to be considered.
As you can see, what appears a simple policy announcement will have an enormous
ripple effect on millions of people in retirement and for their children.

In summary, there are so many variables that working out the best outcome, both now
and into the future, is confusing and highly mathematical.

The policy is estimated to bring in $59 billion in savings over the next 10 years for
Labor.

But the people most likely to be affected are not the mega-wealthy but the hardworking
mums and dads who diligently contributed into super over the past 20 years
under the assumption it would be a protected environment that would allow them to
draw an income stream in retirement.

James Gerrard is the principal and director of Sydney financial planning firm
www.FinancialAdvisor.com.au

Joseph Cheung (jcheung@dbalawyers.com.au), Lawyer and Daniel Butler (dbutler@dbalawyers.com.au), Director, DBA Lawyers

Under certain circumstances, an individual member’s total superannuation balance (‘TSB’) will be increased by their share of the outstanding balance of a limited recourse borrowing arrangement (‘LRBA’) that commenced on or after 1 July 2018 when the Treasury Laws Amendment (2018 Superannuation Measures No. 1) Bill 2018 (‘Bill’) becomes law.

In Part 1 of our series, we considered how the proposed law applies to members who have satisfied a relevant condition of release with a nil cashing restriction. In Part 2 of our series, we examine how the proposed law applies to members whose superannuation interests are supported by assets that are subject to an LRBA between the superannuation fund and its associate (often referred to as a ‘related party’ in everyday conversation).

For completeness, we note that the proposed law applies to both members of self managed superannuation funds (‘SMSFs’) and other funds with fewer than five members. For the purpose of this article series, we will focus on its application to SMSFs.

Lender is an associate of the superannuation fund

Many advisers and commentators have commented that the effect of the proposed law is that a member’s TSB may be increased if their superannuation interests are supported by an LRBA that involves a ‘related party’ lender. In broad terms, a liability is treated as an asset for a member’s TSB purposes. On a more technical level, the wording in the Bill refers to the term ‘associate’, which is a term defined in the Income Tax Assessment Act 1936 (Cth) (‘ITAA 1936’). In contrast, the term ‘related party’ in the superannuation law context is a term defined in the Superannuation Industry (Supervision) Act 1993 (Cth). The definitions are not identical, although there is significant overlap and similarity. Therefore, to thoroughly consider whether the proposed law has any effect on a member’s TSB, SMSF trustees and advisers need to assess whether the lender or proposed lender is an associate of the SMSF.

We illustrate the effect of the proposed law with an example.

EXAMPLE 1

Edward and Ellen are the only members of their SMSF. The value of Edward’s superannuation interests in the SMSF is $1.2 million. The value of Ellen’s superannuation interests is $800,000. The assets of the SMSF comprise of cash only.

Edward is 52 years old. Ellen is 43 years old.

The SMSF acquires a $3 million property. The SMSF purchases the property using all of its cash (ie, $2 million) and borrows an additional $1 million from E&E Pty Ltd, which is a company controlled by Edward and Ellen. Hence, E&E Pty Ltd is an associate of their SMSF.

The SMSF now holds an asset worth $3 million (being the property). The SMSF also has a liability of $1 million under the LRBA.

Of its own cash that it used, 60% ($1.2 million) was supporting Edward’s superannuation interests and the other 40% ($800,000) was supporting Ellen’s interests. These percentages also reflect the extent to which the asset supports Edward and Ellen’s superannuation interests.

Edward’s TSB is $1.8 million. This is comprised of the 60% share of the net value of the property (being $1.2 million) and the 60% share of the outstanding balance of the LRBA (being $600,000).

Ellen’s TSB is $1.2 million. This is comprised of the 40% share of the net value of the property (being $800,000) and the 40% share of the outstanding balance of the LRBA (being $400,000).

The following are some key points to note from the above example.

• An increase in the member’s TSB as a result of their share of the outstanding balance of an LRBA can create liquidity issues for the SMSF. Considering the above example, if Edward’s TSB just before 1 July 2019 is $1.8 million (ie, greater than $1.6 million), this would prevent him from making any non-concessional contributions (‘NCCs’) without an excess in the financial year ending 30 June 2020. This may affect the SMSF’s ability to repay the LRBA and fund pension payments and ongoing expenses.
• An increase in the member’s TSB can also affect other superannuation rights and obligations. (For more information about the various superannuation rights and obligations that depend on a member’s TSB, please refer to the following link: https://www.dbalawyers.com.au/contributions/total-superannuation-balance-milestones/.)

Practical application

LRBAs commenced pre-1 July 2018

The proposed law does not apply to:

• LRBAs that commenced before 1 July 2018; and
• the refinancing of the outstanding balance of an LRBA that commenced before 1 July 2018.

For these circumstances, a member’s TSB is unaffected by the proposed law.

LRBAs commencing on or after 1 July 2018

An SMSF trustee that is considering acquiring an asset via an LRBA should consider the following questions:

1          Is the proposed lender an associate of the SMSF?

2          If so, what is the potential effect of the proposed law on each member’s TSB?

3          Are there are any flow-on consequences, such as the member’s ability to make NCCs, which could affect the SMSF’s ability to repay the LRBA?

Careful planning, analysis and cash flow projections may be necessary before an SMSF trustee can make an informed decision about whether to enter into an LRBA.

The above questions also apply for any SMSF that has commenced an LRBA on or after 1 July 2018. If the lender is an associate of the SMSF and the member’s TSB is affected, the SMSF trustee may need to consider whether there are any strategies available to manage the increase in the relevant member’s TSB that results from their share of the outstanding balance of an LRBA.

Some possible strategies relating directly to the LRBA include but are not limited to:

• Refinancing the outstanding balance of an LRBA to borrow from a lender that is not an associate of the SMSF; or
• Restructuring the lender (where the lender is not a natural person, eg, a company) so that it is no longer an associate of the SMSF — this is a complex strategy and the SMSF trustee should seek expert advice before making a decision to restructure.

Before implementing any strategies, consideration should be given to determine whether the implementation of a certain strategy might trigger the application of the general anti-avoidance provisions such as Part IVA of the ITAA 1936. In this regard, we note that paragraph 4.24 of the Explanatory Memorandum to the Bill states:

…artificially manipulating the allocation of assets that are subject to [LRBAs] against particular superannuation interests at a particular time may be subject to the general anti-avoidance rules in Part IVA of the ITAA 1936 where such allocations formed part of a scheme that had the dominant purpose of obtaining a tax benefit.

(For a discussion on some general strategies to manage a member’s TSB, please refer to the following links:

• https://www.dbalawyers.com.au/smsf-taxation/strategies-to-reduce-your-total-superannuation-balance-part-1/
• https://www.dbalawyers.com.au/smsf-taxation/strategies-to-reduce-your-total-superannuation-balance-part-2/
• https://www.dbalawyers.com.au/contributions/strategies-to-reduce-your-total-superannuation-balance-part-3/)

Additional tip

It is important to note that even if an LRBA can be refinanced with a lender that is not an associate of the SMSF, the proposed law can still operate to increase a member’s TSB where the LRBA has not been repaid by the time that a member satisfies a relevant condition of release with a nil cashing restriction. Under these circumstances, the member’s share of the outstanding balance of the LRBA will increase their TSB. Accordingly, careful planning and monitoring is required even after an LRBA is refinanced with a lender that is not an associate of the SMSF. For more discussion about this topic, please refer to Part 1 of the article series.

Conclusion

As can be seen from the above, an SMSF trustee that is considering acquiring an asset via an LRBA should consider carefully whether the lender is an associate of the SMSF, and if so, the potential effect of the proposed law on each member’s TSB.

The existing and proposed law in relation to TSB is a complex area of law and where in doubt, expert advice should be obtained. Naturally, for advisers, the Australian financial services licence under the Corporations Act 2001 (Cth) and tax advice obligations under the Tax Agent Services Act 2009 (Cth) need to be appropriately managed to ensure advice is appropriately and legally provided.

DBA Lawyers offers a range of consulting services in relation to TSB and LRBAs. DBA Lawyers also offers a wide range of document services.

Related articles

This article is part of a two-part series and the prior part can be accessed here:

• https://www.dbalawyers.com.au/limited-recourse-borrowing-arrangements/total-superannuation-balance-and-limited-recourse-borrowing-arrangements-part-1/

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Note: DBA Lawyers hold SMSF CPD training at venues all around. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.

For more information regarding how DBA Lawyers can assist in your SMSF practice, visit

www.dbalawyers.com.au.

28 November 2018

By Christian Pakpahan (cpakpahan@dbalawyers.com.au), Lawyer and Daniel Butler, Director, DBA Lawyers

This article covers the main ways a person becomes a disqualified person, the consequences of disqualification and the options available to those who are disqualified. (We refer to a trustee in this article as covering both individual trustees of an SMSF and directors of SMSF corporate trustees.)

The ATO will use its powers to render an SMSF trustee a disqualified person where it sees the need, especially for illegal early access breaches. There are other ways a person may become disqualified and some people may not even realise they are disqualified. Acting as an SMSF trustee while disqualified has serious ramifications. It is therefore prudent to be aware of which trustees are or may be disqualified and how a trustee may become disqualified.

Have you ever been convicted of an offence involving dishonest conduct?

The first way a person can be a disqualified person is if they were ever convicted of an offence involving dishonest conduct. This is regardless of whether the conviction was in Australia or a foreign country.

Whether an offence is ‘in respect of dishonest conduct’ is not defined. However, explanatory material to the legislation includes an example of a person convicted of a minor shoplifting offence 20 years ago as an example of an offence involving dishonesty that would disqualify a person. On the other hand, arguably a person convicted of assault is not disqualified, since there is no dishonest intent.

Generally a person who is convicted of an offence involving dishonest conduct is a disqualified person for life. An exception to this rule exists that allows the ATO to waive a person’s disqualified status. Such an application must be made within 14 days of the conviction. Accordingly, a person who anticipates a conviction must act very quickly.

An application outside of this 14 day period may be considered if the ATO is satisfied that there are ‘exceptional circumstances’ that prevented the application from being made within time. Also, a waiver can only apply if the offence did not involve serious dishonest conduct where the penalty is no more than two years’ imprisonment or a fine no greater than a specified amount (eg, 120 penalty units).

Are you a person that is subject to a civil penalty order? 

The second way a person can become disqualified is if a civil penalty order was made against them. Civil penalties are broadly punitive sanctions imposed by the government as restitution for wrongdoing that are imposed through civil procedure rather than criminal process. Civil penalties are typically codified in legislation. Some of the specific civil penalty provisions relating to superannuation are outlined in s 193 of the Superannuation Industry (Supervision) Act 1993 (Cth) (‘SISA’), which include:

In addition to the above SISA provisions, a person may also be disqualified if they are subject to a civil penalty order under other legislation. 

Are you an undischarged bankrupt?

A person who is an undischarged bankrupt is also disqualified, including an undischarged under a foreign bankruptcy law. However, once a person’s bankruptcy period ends, they will cease to be a disqualified person unless they are disqualified for other reasons.

Are you disqualified by ATO action? 

In FY2018 the ATO made 257 SMSF trustees from around 169 SMSFs disqualified. Most disqualifications related to illegal early release of money from SMSFs (around 70% of 169 funds).

Another method open to the ATO is to disqualify because of contraventions of the SISA. The ATO must take into account the nature or seriousness of the contraventions or the number of contraventions. This includes:

• the behaviour of the person in relation to the contravention;
• the extent to which a fund’s assets were impacted by the contravention;
• the extent to which the fund’s assets were exposed to financial risk;
• the number and extent of contraventions over a period of time;
• the nature of the contravention in the overall scheme of legislation; and
• any future compliance risk.

The ATO can also disqualify if it is satisfied that a person is not a ‘fit and proper person’ to be a trustee. In regard to the fitness of a person, the ATO considers whether the person has the relevant skills to be an SMSF trustee having regard to, among other things, the person’s competency and the responsibilities of an SMSF trustee as well as their ability to answer questions put by the ATO.

In regard to whether someone is a proper person to be an SMSF trustee, the ATO considers the person’s general behaviour, conduct, reputation and character. Factors that the ATO will consider in assessing this include, among other things, willingness to comply, proper independence in carrying out the role, whether they have been sanctioned by a professional or regulatory body, management of personal debts, integrity and involvement in entities which have been wound up. Naturally, a person who has outstanding tax debts with the ATO or who has been involved with phoenix company activity would not look good.

Disqualification under this limb can result in adverse public exposure. A person’s disqualified status can easily be obtained from a web search. This adverse public exposure can have a serious adverse impact on a person’s reputation, profession or business. We have had to assist numerous professional and business people who would have suffered considerable loss of business if they were disqualified.

Consequences of being a disqualified person

If a disqualified person knows they are disqualified and continues to act as an SMSF trustee, they will be committing an offence with substantial criminal and civil penalties. Furthermore, it is also an offence for a disqualified person to be an SMSF trustee and not tell the ATO immediately in writing. A disqualified person must also immediately cease being a trustee. Company directors also have an obligation to notify ASIC.

On its website the ATO says that:

if you resign as a trustee your SMSF effectively has six months to restructure itself. Generally this will mean rolling your super interest out of the fund.

Broadly, once an SMSF trustee ceases to act the SMSF has a maximum six month period to comply with the trustee-member rules before it ceases to be an SMSF. An SMSF member is required to be a trustee or a director of a corporate trustee to satisfy the definition of an SMSF. Once disqualified, the person can no longer be an SMSF trustee. The law also prevents the member’s legal personal representative (eg, a person appointed under an enduring power of attorney) from being a trustee in place of a disqualified person. So this may force the person to cease being a member of the SMSF unless another option is chosen.

Options to a disqualified person remaining in an SMSF

Where a person is disqualified the two main options are to roll over the disqualified person’s member benefits to a large (APRA) superannuation fund (eg, an industry or public offer fund) or convert the SMSF into a small APRA fund by appointing an APRA approved trustee.

If the disqualified person has retired or attained 65 or satisfied another condition of release with a nil cashing restriction, they can also consider withdrawing all of their benefits from the SMSF. Corrective action must occur within six months of the trustee’s disqualification.

Conclusion

The matter of disqualification should be monitored well before establishing an SMSF and continually monitored during its life. Advisers should include, for instance, a regular query to clients whether they have been disqualified for any of the above reasons. Clients are not always forthcoming about offences or other indiscretions they may have been guilty of over the years.

*        *        *

This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.

Note: DBA Lawyers hold SMSF CPD training at venues all around. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.

For more information regarding how DBA Lawyers can assist in your SMSF practice, visit

www.dbalawyers.com.au.

9 November 2018

Joseph Cheung (jcheung@dbalawyers.com.au), Lawyer and Bryce Figot (bfigot@dbalawyers.com.au), Special Counsel, DBA Lawyers

If the Treasury Laws Amendment (2018 Superannuation Measures No. 1) Bill 2018 (‘Bill’) becomes law, an individual member’s total superannuation balance (‘TSB’) may be increased by their share of the outstanding balance of a limited recourse borrowing arrangement (‘LRBA’) that commenced on or after 1 July 2018. However, the increase only applies to members:

1          who have satisfied a relevant condition of release with a nil cashing restriction, or

2          whose superannuation interests are supported by assets that are subject to an LRBA between the superannuation fund and its associate (often referred to as a ‘related party’ in everyday conversation).

This article (the first in a two-part series) examines the effect of the proposed law on members who have satisfied a relevant condition of release with a nil cashing restriction. For completeness, we note that the proposed law applies to both members of self managed superannuation funds (‘SMSFs’) and other funds with fewer than five members. For the purpose of this article series, we will focus on its application to SMSFs.

Members satisfying a condition of release with nil cashing restrictions

Under the proposed law, the relevant conditions of release with nil cashing restrictions are:

• retirement;
• terminal medical condition;
• permanent incapacity; and
• attaining age 65.

Only members who satisfy the relevant condition of release with nil cashing restrictions will have their TSB increased. We illustrate this with an example.

EXAMPLE 1

Pierre and Samantha are the only members of their SMSF. The value of Pierre’s superannuation interests in the SMSF is $1 million. The value of Samantha’s superannuation interests is $500,000. The assets of the SMSF comprise of cash only.

Pierre is 61 years old and has retired. Samantha is 54 years old and employed on a full-time basis. For completeness, she wishes to continue working until she attains age 65 years. Therefore, Pierre is the only one who has satisfied a condition of release with a nil cashing restriction.

The SMSF acquires a $2.7 million property. The SMSF purchases the property using all of its cash (ie, $1.5 million) and borrows an additional $1.2 million from an unrelated third party lender using an LRBA.

The SMSF now holds an asset worth $2.7 million (being the property). The SMSF also has a liability of $1.2 million under the LRBA.

Of its own cash that it used, two-thirds ($1 million) was supporting Pierre’s superannuation interests and the other one-third ($500,000) was supporting Samantha’s interests. These proportions also reflect the extent to which the asset supports Pierre and Samantha’s superannuation interests.

Pierre’s TSB is $1.8 million. This is comprised of the two-thirds share of the net value of the property (being $1 million) and the two-thirds share of the outstanding balance of the LRBA (being $800,000).

Samantha’s TSB is $500,000. This is because she has not satisfied a condition of release with a nil cashing restriction. Accordingly, the one-third share of the outstanding balance of the LRBA (being $400,000) does not increase her TSB.

The following are some key points to note from the above example.

• An increase in the member’s TSB as a result of their share of the outstanding balance of an LRBA can create liquidity issues for the SMSF. Considering the above example, if Pierre’s TSB just before 1 July 2019 is $1.8 million (ie, greater than $1.6 million), this would prevent him from making any non-concessional contributions (‘NCCs’) without an excess in the financial year ending 30 June 2020. This may affect the SMSF’s ability to repay the LRBA.
• An increase in the member’s TSB can also affect other superannuation rights and obligations. (For more information about the various superannuation rights and obligations that depend on a member’s TSB, please refer to the following link: https://www.dbalawyers.com.au/contributions/total-superannuation-balance-milestones/.)
• Where the loan has not been repaid by the time that a member satisfies a relevant condition of release with nil cashing restriction, the member’s share of the outstanding balance of the LRBA will increase their TSB. Considering the above example, although the one-third share of the outstanding balance of the LRBA does not increase Samantha’s TSB, if she subsequently satisfies a relevant condition of release with nil cashing restriction (eg, retirement or attaining age 65 years) before the LRBA is repaid, her share of the outstanding balance of the LRBA will increase her TSB.

Practical application

LRBAs commenced pre-1 July 2018

The proposed law does not apply to:

• LRBAs that commenced before 1 July 2018; and
• the refinancing of the outstanding balance of an LRBA that commenced before 1 July 2018.

For these circumstances, a member’s TSB is unaffected by the proposed law.

LRBAs commencing on or after 1 July 2018

An SMSF trustee that is considering acquiring an asset via an LRBA should consider the potential effect of the proposed law on each member’s TSB where the members satisfy or are about to satisfy a relevant condition of release with a nil cashing restriction. For example, if a member is about to satisfy a condition of release with a nil cashing restriction because they have met preservation age and are about to enter into retirement for superannuation law purposes, the SMSF trustee may need to consider how the member’s TSB will be calculated if the proposed law comes into operation and upon the member entering into retirement for superannuation law purposes. The SMSF trustee may also consider whether there are any flow-on consequences, such as the member’s ability to make NCCs, which could affect the SMSF’s ability to repay the LRBA. Careful planning and forecasting may be necessary before an SMSF trustee can make an informed decision about whether to enter into an LRBA.

Similarly, for any SMSF that has commenced an LRBA on or after 1 July 2018, the SMSF trustee should monitor and assess the effect that the proposed law has on each member’s TSB. If the member’s TSB is affected, the SMSF trustee may need to consider whether there are any strategies available to:

1          manage the increase in the relevant member’s TSB that results from their share of the outstanding balance of an LRBA; and

2          ensure that the LRBA can be repaid. For example, the repayment of an LRBA might be assisted by admitting additional members into the SMSF who have the ability to make NCCs. Naturally, the SMSF trustee should consider thoroughly the advantages and disadvantages of admitting additional members into an SMSF before making a decision.

Before implementing any strategies, consideration should be given to determine whether the implementation of a certain strategy might trigger the application of the general anti-avoidance provisions such as Part IVA of the Income Tax Assessment Act 1936 (Cth).

In relation to this aspect, we note that paragraph 4.24 of the Explanatory Memorandum to the Bill states:

…artificially manipulating the allocation of assets that are subject to [LRBAs] against particular superannuation interests at a particular time may be subject to the general anti-avoidance rules in Part IVA of the ITAA 1936 where such allocations formed part of a scheme that had the dominant purpose of obtaining a tax benefit.

(For a discussion on some general strategies to manage a member’s TSB, please refer to the following links:

• https://www.dbalawyers.com.au/smsf-taxation/strategies-to-reduce-your-total-superannuation-balance-part-1/
• https://www.dbalawyers.com.au/smsf-taxation/strategies-to-reduce-your-total-superannuation-balance-part-2/
• https://www.dbalawyers.com.au/contributions/strategies-to-reduce-your-total-superannuation-balance-part-3/)

Conclusion

As can be seen from the above, an SMSF trustee that is considering acquiring an asset via an LRBA should carefully plan and consider the potential effect of the proposed law on each member’s TSB where the members satisfy or are about to satisfy a relevant condition of release with a nil cashing restriction.

The existing and proposed law in relation to TSB is a complex area of law and where in doubt, expert advice should be obtained. Naturally, for advisers, the Australian financial services licence under the Corporations Act 2001 (Cth) and tax advice obligations under the Tax Agent Services Act 2009 (Cth) need to be appropriately managed to ensure advice is appropriately and legally provided.

DBA Lawyers offers a range of consulting services in relation to TSB and LRBAs. DBA Lawyers also offers a wide range of document services.

*        *        *

Note: DBA Lawyers hold SMSF CPD training at venues all around. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.

For more information regarding how DBA Lawyers can assist in your SMSF practice, visit

www.dbalawyers.com.au.

20 November 2018