So tell me, what exactly is the ATO's role in SMSFs?
15 July 2015 | Gordon Mackenzie, University of New South Wales
In 1999 the regulation of self-managed super funds (SMSFs) was moved from the Superannuation and Insurance Commission (subsequently Australian Prudential Regulation Authority (APRA)) to the Australian Taxation Office (ATO) and at that time, it was suggested that the ATO got that job because SMSFs were seen to be just tax play vehicles, not serious retirement funding vehicles.
So, what we have been looking at is whether in 2015, when SMSFs hold a third of the $1.8 trillion in super, is it still correct to say that the ATO's role in SMSFs is just revenue protection or does the ATO have a role in ensuring that SMSF members have a comfortable retirement?
Our starting point has been to compare the way that the ATO regulates SMSFs with the way that APRA regulates the super funds it is responsible for (retail, industry and corporate super funds for example) against five criteria.
First, we looked at the main rule which links the way that a super fund is managed with the tax concessions that they get on contributions, fund income and benefits: a "complying superannuation fund". What we saw there is that the compliance test for SMSFs is different to that for the other type of super funds and, generally, it relates to ensuring that the assets of the SMSF are not misused, such as being a liquidity vehicle for a fund member who has an otherwise illiquid asset. What we also saw was that the chances of non-SMSFs falling foul of this rule are virtually zip.
Second, we looked at the "covenants" in super fund trust deeds. Covenants are, in effect, standards of conduct by which the trustee must run the fund. Again, these differ between SMSFs and non-SMSFs and, importantly, the covenants applying to non-SMSFs are all directed at protecting the members of the fund from mismanagement by the trustee around various risks that members may be exposed to. On the other hand, the covenants by which a SMSF trustee must comply with relate again to protecting against misuse of the fund assets.
One important covenant for SMSFs is that they have an "Investment Strategy", which is referenced to things about investing, such as having regard to asset/liability, liquidity and diversification. Interestingly, while the ATO will, on audit, want to see the SMSF's Investment Strategy, that is about as far as they go. They do not comment on whether it is good or bad. They just want to see that one exists.
Third, we looked at any differences in the application of the "sole purpose test" between the two types of super funds. It's the principal regulatory tool for SMSFs and it comes from a 1967 High Court decision about whether a Western Sydney solicitor's super fund, which was running a property development business, was in fact, a super fund (it wasn't.) In any case, with two exceptions, all the cases on the sole purpose test, and there are quite a few of them, have involved SMSFs. It's not a relevant issue for non-SMSFs. Next, we looked at the rules restricting how a super fund invests. Again, with two exceptions, these rules apply equally to both types of super fund, but what we see is that most of these restrictions are about related party transactions, which is also simply not an issue for non-SMSFs.
Finally, we looked at the difference in the style of regulation between the ATO and APRA. This is very telling, as the way the ATO regulates SMSFs is against breaches of black letter laws which, necessarily, can only be done after the breach has occurred. On the other hand, APRA is a prudential principle based regulator, which assesses the risks to members in the way that the super fund is being run and then offers guidance to the trustees about how to manage those risks. Of course, that is regulation in advance of a breach, besides being directed at protecting members' interests.
Overall, our preliminary view is that the ATO simply regulates SMSFs to ensure that they are used for the purposes for which they get tax concessions.
The next stage for us is to compare SMSF regulation with the equivalent type of pension fund in the US, Canada and the UK, to see how they do it and why. Also, we will have a look at how some other tax preferred funding vehicles are regulated, such as venture capital funds.
"So what?", I hear you say. Why do we need to know how SMSFs are regulated? Well, they do hold over $500 billion in assets so it would seem sensible to understand how they are regulated just in case we can make some suggestions for improvement.
Note: originally published in Australian Superannuation Law Bulletin, July 2015, Volume 27 No 6