For clients who have or are a self managed super fund, it is good practice to periodically remind trustees to ensure that they have met all of their compliance obligations, including maintaining a sound and customised investment strategy that is specific to their fund.
ATO activity in the SMSF space is increasing with a new focus on investment strategy obligations. This focus on investment strategy obligations comes about as part of a broader compliance project initiated by the ATO to investigate failings in the SMSF sector, which also includes investigation into some 24,000 SMSFs that have failed to lodge tax returns in the coming months.
In terms of the investment strategy itself, which is the focus on this article, it is important to be familiar with the ATOs recently released guidance titled “Your Self Managed Super Fund Investment Strategy QC23320” in relation to your SMSF clients and to identify whether clients have deficiencies in this regard and what level of corrective action should be put in place to mitigate any exposures to the SMSF being regarded as non-compliant.
In August 2019, the ATO announced its intention that around 17,000 SMSF trustees and their auditors would be contacted where the ATO’s records indicate that the SMSF may be holding at least 90% of its funds in a single asset or single asset class. The ATO announced its concern that “some trustees haven’t given due consideration to diversifying their fund’s investment… this can put the fund’s assets at risk”.
This issue of lack of diversification goes against the fundamental principle behind having an investment strategy, which is to have and maintain a plan for making, holding and realising assets that are consistent with the trustee’s objectives and retirement goals for members. Lack of diversification, it is thought, can expose the SMSF and its members to an unnecessary level of risk if such a significant investment were to fail.
The announcement also advised that trustees would be asked to review their investment strategy to ensure that it complies with regulation 4.09 of the Superannuation Industry Supervision (Regulations) 1994. Accordingly, trustees were advised to have their “documentation” ready for the SMSF’s approved auditor in anticipation of the next audit so the auditor can express an opinion on the fund’s compliance with regulation 4.09.
SIS rules regarding diversification
Although there is no express prohibition in the SIS legislation to prevent an SMSF from holding 90% or more of its funds in a single asset or single asset class, the investment strategy provisions requires each trustee to:
formulate, review regularly and give effect to an investment strategy that has regard to the whole of the circumstances of the fund including, but not limited to… the risk involved in making, holding and realising… the fund’s investments… the risks from inadequate diversification… having regards to its objectives (section 52B(2)(f))
Consequently, there is an obligation to ensure that the fund is not at risk from factors such as “inadequate diversification”.
Although this does not explicitly prohibit the holding of a single asset or single asset class, as with any tax position, it is important to comply with the Commissioner’s guidance and policies on the issue given the ATO’s broad powers of investigation and expansive penalty regime for non compliance. Accordingly, SMSFs who are holding 90% or more of their fund in a single asset or single asset class are most at risk of the ATO’s attention.
The SMSF investment strategy review
The ATO’s identification of this risk of inadequate diversification can be remedied by a sound SMSF investment strategy that is implemented.
In summary, the ATO has confirmed that an SMSF investment strategy should be in writing and tailored to the particular SMSF’s situation. Advisers should therefore shy away from simply providing a “cookie cutter” or “template” document for the trustee to adopt which has no regard for the particular circumstances of the fund.
As such, the ATO sets out the following details which should assist trustees in complying with the investment strategy:
- what needs to be included in the investment strategy;
- whether any restrictions exist under the SIS legislation regarding the SMSF investment;
- what “having regard to diversification” means and whether the specific SMSF can in fact invest all retirement savings in one single asset or single asset class*;
- what “giving effect to an investment strategy” means;
- how often the trustee should review the strategy;
- identification of the auditor’s role in relation to the investment strategy;
- the implications that can arise on non-compliance;
- the action the ATO could take if an auditor lodges an Audit Contravention Report; and
- who should prepare, update or review an investment strategy.
* in certain cases, it may be appropriate for an SMSF to invest up to 100% of its fund in a single asset, such as business real property. However, if the intention is to do so, the trustee should ensure that the investment strategy has regard to the additional risks arising from “inadequate diversification” in relation to the likely return from the investment, liquidity, expected cash flow requirements and the ability to discharge its existing and prospective liabilities.
In the ATO’s guidance, they confirm that an SMSF investment strategy should be tailored and in writing. The ATO reiterates that the factors set out in regulation 4.09 also need to be addressed in relation to the SMSF specifically, having regard to any particular circumstances of its members (for example age / risk appetite).
This includes identification of the:
- risks in making, holding and realising the investments;
- likely return from the investments;
- composition of investments and how diversified the assets are noting that trustees are free to choose what assets to invest in and the ATO recommends that trustees identify on a proportionate basis, what the asset mix should be;
- liquidity of the fund’s assets;
- ability to pay benefits; and
- level of insurance cover required.
The investment strategy is intended to be a working document and the ATO considers that it should be reviewed at least annually to ensure that the fund, comprising of the investments of the SMSF, has been managed in a way that is compliant with the investment strategy.
Certain other events should also trigger a review including changes to the member base, financial market corrections and on the happening of significant events that impact the investments in the fund.
In the unfortunate event of non-compliance it is important to be aware that the Commissioner has broad powers to impose penalties on the trustee of the SMSF or issue administrative directions (ie. rectification directions and / or education directions).
From a financial penalty perspective, individual trustees are most at risk of personal liability for failures to comply with the SMSF investment strategy obligations, whereas trustee directors are afforded limited liability through acting on behalf of a company.
For example, at the time of writing, the penalty for a breach of these requirements is $4,200 per trustee. That means if there is more than one individual trustee, each individual will be fined $4,200. Alternatively, where a corporate trustee is involved, a single fine of $4,200 applies to the company, not its directors. This rule applies across the entire SMSF penalty regime and unless very exceptional circumstances exist, it is preferable for a trustee to take the form of a company instead of an individual/s.
In addition to financial penalties, the Commissioner may also direct the trustee to remedy the breach by way of an administrative direction in the form of a rectification direction, an education direction or both where he “reasonably believes” that a trustee or a director of a corporate trustee has contravened the SIS legislation.
A ”rectification direction” will require the trustee to undertake specific action to rectify the contravention within a specified timeframe and to provide evidence of compliance with that direction.
An “education direction” will require a person (for example a director of a corporate trustee) to undertake a specific course of education within a specified time frame and provide evidence of completion of that course.
Tax agents providing advice on SIS legislation
It is important to be aware that there are limitations in what a tax agent can and cannot advise on in relation to SMSFs. As a general rule, accountants and other SMSF advisers who are not covered by an Australian Financial Services Licence, are not permitted under the Corporations Act to provide financial product advice or related financial services.
In terms of the preparation of an investment strategy, there is some conjecture in the industry regarding whether or not this is or isn’t a “financial product”. Given this, an accountant acting without an AFSL who prepares an investment strategy is at risk of contravening the Corporations Act and could therefore trigger enforcement action from ASIC (including significant penalties) plus from a civil perspective is potentially personally exposed to damages for poor investment performance where professional indemnity insurance is inadequate.
We would even go so far to say that a non-licenced advisor simply providing an investment strategy template creates an exposure on the basis that this could be considered “financial product advice” or even a “financial product”.
We have extensive experience in submitting voluntary disclosures for contraventions of the SIS legislation which has either come about through self audit or following the issue of an Audit Contravention Report.
If you have identified any deficiencies in your SMSF client’s satisfaction of their compliance obligations regarding investment strategies, please contact us so that we can identify what corrective action could be taken. We have found that the Commissioner is open to taxpayers who voluntarily disclose non-compliance and does have a discretion to remit penalties where the SMSF agrees to rectify the breach and undertake an education direction.
We’re here to help.
Ann-Maree Ventura Special Counsel