A COMMON GOAL: Securing retirement incomes for Australians
Strong growth in self managed super funds presents the community with a number of challenges.
Firstly, the sharp rise in self managed super fund numbers means that there’s a lot more trustees with their ‘learner plates’ on, and there are risks around making sound investment decisions.
Secondly, the assets in the funds have grown significantly but they remain ‘off limits’ until the trustees reach the preservation age, and this may still be some time off.
Combined, these two features show the important need of all trustees – not just new trustees and prospective trustees – to properly understand superannuation and the rules that apply.
The rate of growth in self managed super funds has been remarkable. In 2007, 47,000 new funds were established bringing the total number to 372,000 (see Appendix, Chart A). In the two years to June 2007 assets in self managed super funds increased by around $130 billion to almost $300 billion – a rise of 76% (see Appendix, Chart B). That accounted for around one quarter of the total $1.15 trillion in superannuation assets. 1
Average fund holdings now stand at around $800,0002. Since most are currently in the accumulation phase of the fund’s life this figure is expected to grow further.
That’s a lot of retirement savings under self management by large numbers of Australians.
The ATO’s regulatory role
The intent of the past and current Government’s retirement income policies is about the future financial security of many Australians.
The purpose of Australia’s superannuation system is to help and encourage people to achieve a higher standard of living in retirement than would be possible from the age pension alone.
For trustees of self managed super funds, the law prescribes the type of investments that are likely to leave them with their intended retirement income. So it is important that they know their obligations and that they follow them. Breaches of the rules may leave them short on their retirement.
In seeking to help trustees and auditors, we recognise the contribution of others. We will continue to work with industry associations such as the Self-Managed Super Fund Professionals’ Association of Australia (SPAA) to safeguard the retirement incomes of Australians.
Some of our initiatives have had significant design input from SPAA and its members.
Not surprisingly, with the strong growth in the number of new trustees we’re spearheading efforts to ensure that new trustees get off to a better start; to raise the capability of approved auditors; and to improve the effectiveness of our work.
Gap between motivation and responsibility
The compliance issues we’ve seen in the past 12 months show the main areas where some trustees are getting it wrong, and where professional advisers, such as approved auditors, need to be on guard.
The issues highlight the fact that one of the main motivators for establishing these retirement savings vehicles – desire for flexibility and control over the investment of the assets – is not always being matched by higher levels of accountability.
Loans to others
Loans made by funds are a major source of concern. They account for 30% of the audit cases currently under investigation. Prohibited loans are also the single highest contravention reported by fund auditors.
We are currently reviewing 500 funds where their returns indicate that over 80% of assets have been loaned to others.
In these cases we have been looking to whom the loan was made. For example was it an arm’s length transaction, and were market interest rates charged?
In one fund an audit revealed 98% of its total assets had been ‘loaned’ to a member. There was no loan agreement and no repayments had been made. It was subsequently revealed that the loan was used by the fund member for a business venture and that it could not be repaid.
Such ‘loans’ are in fact early access which do not meet regulatory requirements.
In some cases illegal early access has occurred in a more blatant way.
Last year trustees of a self managed fund were fined $30,000 and $32,000 in costs for selling a property belonging to the fund and using the $150,000 in proceeds to pay a private debt. The title of our booklet “It’s your money but not yet” is self explanatory.
Another major area of risk is the presence of non-allowable assets within funds.
Among the 85 enforceable undertakings made by self managed super funds this year, exceeding the 5% limit on in-house assets was the most common trigger.
The new annual limits that cap contributions to superannuation3 have not always been observed. More than 200 people have told us they made contributions to their self managed funds over the $1 million cap during the transitional period from Budget night 2006 to 30 June 2007. In one instance a deposit of $24 million was made. These people have typically received transitional release authorities, allowing them to withdraw excess contributions without penalty.
Prior to implementation of the current capping regime, we would generally have expected on past indications, some 7-8,000 people to have been making contributions in excess of the limits. Our data matching capabilities are good, and we will be checking that trustees have adjusted to the legislative changes.
We have already identified a substantial number of cases where it appears that the transitional contribution cap has been exceeded, and where the relevant trustees have not come forward. We’ll be in touch with a number of trustees in the upcoming weeks, and penalties may apply. So if you are in this category, please come forward voluntarily so that we can sort things out.
Our increased audit coverage will of course also be checking to ensure that contributions are reported accurately on the Member Contribution Statement.
In general self managed funds are not able to borrow in their own right. Recent legislation does nevertheless provide for the use of instalment warrants by funds to purchase approved assets.
However we are aware of cases where borrowings are made to purchase fund assets, and interest is wrongly claimed as a tax deduction.
Rectifying reported breaches
Lack of urgency in rectifying breaches identified in auditor contravention reports is unfortunately more common than desirable. While some 50% of breaches are reported to us as already rectified, it is of concern that 25% are only actioned after the ATO has followed-up with the fund and 25% still fail to rectify despite our contact. We escalate these cases for a higher level of enforcement action and a fund can face a range of sanctions under the SIS Act, including being made non-complying.
Unreported tax on source of funds
The strong flow of funds into self managed super has prompted us to examine their sources. We are identifying taxpayers who use under-reported or concealed sources of income.
We are also investigating cases where real property has been placed into self managed funds without paying capital gains tax on the transfer.
Using available data we are also checking that the 2000 or so trustees who accessed the transitional $1 million contribution cap last year met their obligations in respect of capital gains tax.
Addressing compliance issues
Additional Government funding provided to step up our focus on self managed super funds will see an expansion of our compliance activities with over 300 officers involved in a range of compliance activities. Briefly they cover the following.
Increased reviews and audits
We are using these staff to examine the range of data available to us such as contravention reports provided by the fund’s approved auditors, lodgment history, member contribution statements and other reporting obligations.
An additional 6600 reviews and audits will be completed this financial year, taking the total to around 11,000. This year we are focussing on:
- auditor contravention reports: approximately 2600 reviews are being carried out of significant Superannuation Industry Supervision (SIS) Act breaches
- new registrants: we are well underway with a survey of 3000 new trustees to better understand their knowledge of their role and responsibilities at the beginning of the fund’s life. We are using this information to better target our range of information and education initiatives for new trustees.
Improving lodgment behaviour
In 2007–08 all self managed super funds that fail to lodge their return will be contacted immediately for follow-up action.
Around 70% of self managed funds lodged their 2006 return on time and a similar trend is continuing for 2007. Approximately 50,000 2006 returns were lodged late, potentially attracting penalties for late lodgment. In 2007-08 we will be reminding funds to lodge their 2007 return by the due date. Funds that are unresponsive may be subject to penalties for failing to lodge by the due date or we might take prosecution action in cases of serious breaches.
Understanding the new trustee environment
An important part of our compliance program this year has been to better understand the motivations and knowledge levels of trustees, particularly when they start out. The preliminary results from a recent survey of 3000 new trustees highlight gaps in knowledge and raise questions about some trustees’ current ability to carry out their responsibilities.
Ninety percent of new trustees surveyed had an adequate knowledge of the basic processes involved in annual lodgments, annual audits, separation of assets and restrictions on the use of funds for private purposes.
However, beyond these basics, the results show very uneven knowledge of trustee responsibilities. For example:
- approximately twenty one percent have been assessed by our compliance staff as having either ‘low to medium’ or ‘low’ knowledge of their obligations, such as the 5 per cent limit on in-house assets and the need to conduct the business of the trust at arm’s length
- over thirty percent could not provide an explanation of the sole purpose test, and around twenty percent were unaware of the new contributions cap introduced by the Super Simplification law
- more than fifteen percent admitted to not having an investment strategy (which is a mandatory requirement) and over twenty five percent were unaware of legal restrictions on the types of assets self managed funds can acquire from members.
The survey also highlights the extent to which trustees rely on professional advice. Ninety three percent of trustees said they received professional assistance in setting up their fund. Forty eight percent of these trustees turned to their accountant, twenty five percent to their financial planner and eight percent received assistance from their tax agent.
Prevention is better than cure: targeting new trustees
If we can help new trustees get on the right path early on, they are more likely to follow the rules designed to protect their retirement income. This ‘prevention is better than cure’ approach is consistent with other ATO initiatives for example, our Small Business Assistance Program for new and established businesses.
New initiatives to help new trustees
We have developed a self managed fund start-up kit which we will be providing to all new trustees, and we will be releasing a new booklet in the coming weeks to further help trustees entitled “How your self managed super fund is regulated”. This booklet helps trustees, especially new trustees, get across the fundamentals quickly and easily.
We are also currently upgrading the content on our website. In talking with trustees and their advisers we’ve come to understand that they need the information to be presented in a way that relates to the stage trustees are at in the fund’s lifecycle. A more intuitive approach will see the information organised around events such as, initiation, establishment, accumulation, drawing down and wind up – the key phases and points in the lifecycle of the fund. The information will also be presented as practical guidance rather than as an exhaustive legal text.
For new funds, we are also complementing these initiatives by undertaking a program of special compliance checks to assist trustees step up to their new role and responsibilities. This includes obtaining written confirmation certifying that a trustee properly understands their obligations, as is now required by law.
We are very grateful for the input and feedback we have had from industry professionals in developing these initiatives.
Ensuring auditors are meeting their role and responsibilities
Approved auditors perform a special role in the integrity of the self managed super system.
As part of their role they identify and rectify problems with a fund and they can have a strong positive influence on trustees, particularly new trustees.
Our early survey results confirm the extent to which trustees depend on professional advice and guidance to meet their responsibilities. So the need to ensure high levels of competence and integrity among superannuation intermediaries is obvious.
Auditing the auditors
Using a risk based approach, we are reviewing and auditing around 900 approved auditors this financial year.
While a majority of auditors are doing a good job there are some who are not. We are seeing some auditors focusing solely on financial issues and paying insufficient attention to regulatory requirements.
Specific issues identified with approved auditors include:
- failure to follow basic auditing standards and in particular keeping proper records (this is not only a breach of the SIS Act but also of the auditor’s own professional standards)
- failure to report contraventions (where a contravention is later identified by us)
- lack of independence where auditors also act as a trustee’s accountant and/or financial planner.
One visit we made to an approved auditor revealed that he knowingly allowed his client’s return to be lodged without completing an audit. The auditor’s file had no audit plan, no representation letter and no source documentation for an identified issue. It further transpired that the auditor had not performed the regulatory component of the audit for this fund nor for the funds of other clients. His response was that he only charged a low fee! The auditor has entered into an enforceable undertaking not to conduct any audits and we are considering whether to disqualify him as an approved auditor or refer him to his professional association for appropriate disciplinary action.
Over the three years 2007–10 we will be contacting one in five approved auditors to ensure they are meeting regulatory requirements. We are consulting with the professional associations about this work because the majority of errors currently made by auditors are due to low levels of knowledge rather than intentional disregard of their responsibilities. This financial year we have referred five auditors to their professional bodies and a further six have entered into an enforceable undertaking with the ATO to improve their competence and performance.
While having a 20% coverage of approved auditors, the impact of our work will benefit a larger proportion of self managed funds. For example, in the latter part of this year we will audit around five large auditing firms that provide services to significant numbers of self managed super funds.
Other initiatives to make your obligations easier, cheaper and more personalised
We will be streamlining trustees’ reporting obligations into a single form covering their income tax, regulatory and member contribution statements for 2007–08.
On average, the ATO call centre answers 200 calls and receives around 35 written enquiries from trustees of self managed funds a day. Our phone services and our letters have undergone some improvements in the past 12 months and we are committed to ongoing improvements to make it easier and faster for people to deal with us.
Preliminary results from our new trustee survey show that 37% use ATO information prior to establishing a fund. Of these 60% source the information from our website, hence our focus on improving the website.
When I spoke to you 12 months ago I flagged our plans to produce and distribute a regular electronic newsletter for self managed super funds. I’m pleased to report that the newsletter’s third issue was published in December and that subscriptions have almost doubled from the initial 6000 subscribers. Our main objective is to provide practical and accessible guidance.
For those requiring technical exposition of the requirements of the SIS Act, we have issued five public rulings and determinations, including advice on the application of the sole purpose test and the prohibition on using the fund to provide financial assistance to a member or relative.
On another front, we are providing more private advice for those requiring a technical assessment of their individual position.
We have been developing an online auditor tool which will make it easier for auditors to ensure that all the regulatory requirements are covered. We will also be providing them shortly with new reporting guidelines.
Into the future we are looking at producing guides for trustees on investment strategy and record keeping. Both of these are areas that show up in our survey results as requiring greater attention by trustees.