There are several changes on the horizon set to have a significant impact on the financial advisory sector. Grant Abbott examines how they will affect SMSF practitioners.
Can you believe that we are already into the 2018/19 income year? Is it just me or is time just flying by?
There is so much going on in the world, so much change, and SMSFs, my one true love (apart from my family, of course), are also being buffeted by change; some very apparent changes and some not so, particularly for those who are not immersed in SMSFs 24/7 as I am. So this is as good a time as any to look to 2019 and consider some of the future possibilities, opportunities and threats to our current SMSF culture and industry.
"Like most professionals, I fully support, particularly in SMSFs, the idea of having the highest standards possible."
The big changes
1. Professional SMSF educational standards and CPD
The SMSF advice industry was highlighted in the banking royal commission and even the most diehard SMSF supporters would have to say it was not pretty. I could write a whole story on what went on, but let’s just call it a day and move on.
First and foremost is the requirement for all advisers currently working in the financial advice arena, including those providing SMSF advice, to meet new educational standards. The new laws can be found in the Corporations Amendment (Professional Standards of Financial Advisers) Act 2017 and are explained on the Financial Adviser Standards and Ethics Authority (FASEA) website.
If you are unaware, an SMSF is not a financial product, but a basket of financial products as the Corporations Act equates a financial product to an interest in a superannuation fund. So becoming a member, making contributions, being paid a lump sum, income stream or pension, receiving a disability or temporary incapacity payment, making a binding death benefit nomination and even a non-binding nomination are all financial products that require licensing where personal advice to an SMSF member is provided. And that person providing the advice is now called “a relevant provider” and subject to the four professional educational and training standards.
This is a significant change to the current position under the Australian Securities and Investments Commission’s (ASIC) Regulatory Guide RG 146 where Australian financial services (AFS) licensees, their staff and authorised representatives (AR) had to meet competency standards as enforced by the licensee. And, of course, this non-robust self-assessment system geared toward lightweight training and competency standards has come back to haunt the profession in the royal commission and provided added impetus and focus on implementing the new training and educational requirements.
Importantly, there is no more self-assessment. FASEA is the national standards body and everything is run through it. FASEA will consult with industry, but at the end of the day it has the power of the Corporations Act to enforce the standards. This will come as a huge shock to AFS licensees and also current ARs who will need to upskill significantly.
In short, section 921B of the Corporations Act 2001 provides the following standards for any person advising on a financial product. I have reproduced the actual law for two reasons: firstly, it is easy to read and understand and, secondly, as an SMSF adviser, the skills competency standards require an adviser, to read, understand and apply the legislative provisions that apply to SMSFs.
The four training and education standards: section 921B:
2. The first standard is that:
- the person has completed a bachelor or higher degree, or equivalent qualification, approved by the standards body under section 921U;
3. The second standard is that the person has passed an exam approved by the standards body.
4. The third standard is that the person has undertaken at least 1 year of work and training that meets the requirements set by the standards body.
Continuing standard for relevant providers
5. The fourth standard is that the person meets the requirements for continuing professional development set by the standards body.
For SMSFs there is a national financial services training package for “providing advice on SMSFs” and this will become the core of the four standards. That package has five competency standards including: FNSSMS603 – Apply legislative and operational requirements to advising in self-managed superannuation funds. One of the skills requirements, among hundreds of others is: identify and interpret the legislative requirements to maintain a self-managed superannuation fund.
In my opinion, if FASEA and PricewaterhouseCoopers, which is providing advice on the continuing professional development (CPD) package for FASEA, enforce these knowledge and skills requirements across the four standards, then the problems faced in the royal commission will fade over time. Like most professionals, I fully support, particularly in SMSFs, the idea of having the highest standards possible.
There are some big questions:
- Accountants have to complete their own professional year, so will they complete another one for SMSF advice? Hopefully the accounting bodies see the sense to combine the two.
- The year 2024 is not that far away for current financial advisers to complete a part-time degree if needed, so the issue is whether to stay or move out of the industry or simply retire.
- Who will be competent enough to act as a supervisor for new SMSF advisers?
- With the Australian Financial Complaints Authority (AFCA) introducing a no-cost complaints service with awards of up to $500,000, will the larger AFS licensees have an appetite to authorise SMSFs or just choose to go direct through SMSF expos with organisations such as the SMSF Association?
The government has decided to combine the Financial Ombudsman, the Superannuation Complaints Tribunal and the Credit and Investments Ombudsman. To start from 1 November 2018, this multifaceted body will send shockwaves through the industry. It is unsurprising some large wealth fund managers and AFS licence holders are suggesting financial advisers, like tax agents, should be independently licensed as AFS licensees and authorised representatives are phased out.
The AFCA fact sheet published by Treasury provides that “in line with the Ramsay review recommendation, the government has undertaken consultation on the monetary limits that AFCA should operate under, upon commencement.
The government has decided that AFCA will commence operations with the following monetary limits:
- a monetary limit of $1 million and a compensation cap of $500,000 for most non-superannuation disputes,
- unlimited monetary jurisdiction for superannuation disputes,
- no monetary limits and compensation caps for disputes about whether a guarantee should be set aside where it has been supported by a mortgage or other security over the guarantor’s primary place of residence, and
- a monetary limit of $5 million and a compensation cap of $1 million for small business credit facility disputes.
I have read the Treasury Laws Amendment (Putting Consumers First Establishment of the Australian Financial Complaints Authority) Bill 2017 and some of the key impact areas for SMSF advice are:
- SMSF members and trustees may commence a complaint against an adviser on a no-cost basis. This will be promoted extensively by the government. Defending it will cost the adviser time and resources, no matter how small the complaint.
- There is no punishment, compared to the current schemes for vexatious complainants.
- Unlicensed accountants can still be brought into a complaint where it deals with non-SMSF matters, such as recommending a person withdraw funds from a superannuation fund to transfer to an SMSF.
- Expert panels will be used by AFCA in specific areas of expertise, such as SMSFs where the matter is complex and also to determine any losses.
For all SMSF advisers, licensed or unlicensed, make sure your documentation is tight, your advice is based on the actual laws and regulatory guidelines and that you can prove, in front of an expert panel or AFCA representatives, you met and displayed the five skills competency standards in the “provide advice in SMSFs” national financial services training package.
3. Increase in SMSF members to six – the birth of the family SMSF
The maximum number of members in an SMSF is to be increased from four to six from 1 July 2019. I am not sure why there is a delay with an election in between and who knows when the legislation will be introduced.
From my perspective, it now means there are three types of SMSF:
i. The do-it-yourself fund
This is the preserve of the single investor who, with or without their spouse, uses the SMSF to invest primarily in shares. Being canny in the saving money department and watching every penny, they do their own accounts and get cut-price auditing. The proposed rules to have complying SMSFs audited every three years was welcomed by this group. But the thought of losing their precious franking credit refunds has them in a lather and trash-talking the opposition policy. And the idea of bringing other family members into the SMSF would mean a loss of control, so don’t go there with the do-it-yourself fund trustees, who are still individual trustees.
ii. The common SMSF
The common SMSF is dominated by one or two members, generally with a corporate trustee, and the trustee making the investment decisions with a very basic strategy. Set up by an accountant, it will have a simple SMSF deed, a binding death benefit nomination, either property or shares and for the older members primarily cash. Members are in or close to pension, may be affected by the pension transfer balance limits and lodge their returns and investment strategies months after year end. Fees are always looked at, considered, but as their SMSF gets bigger, they don’t rock the boat with their accountant. It’s a plain, average, common SMSF. Much of the strategy the trustees can glean from the papers or the internet.
iii. The family SMSF
This is not a newcomer and I watched a family SMSF video of mine from 2002. The reasons family SMSFs did not take off were the limitation of membership to four, low super fund balances at that time, the older members were still in their early fifties with children at university or school, and a concern over the longevity of SMSFs – a mistrust in super overall.
Well 16 years on and much has changed. The average size fund has increased by 600 per cent, adult children have been working for a decade and have more than $200,000 in retail or industry-based super funds, SMSFs are now a fixture, tax-free super post age 60 is a given and the family’s financial welfare is all important to the leading members.
Family SMSFs are primed for take-off and since the May budget I have road tested my family SMSF ideas and strategies to more than 500 trustees of common SMSFs, and at least 70 per cent of them want to upgrade their SMSF to a family fund. Of course, the strategies for a family SMSF are not replicable by the trustees, meaning more and higher-paid consulting work for family SMSF advisers.
Here’s my tip: educate your clients on the benefits and pitfalls of a family SMSF and let them choose whether they remain in a common SMSF or upgrade to a family fund. And do it now before they hear about it in the media.
4. The NALI nasty
This is bad, very bad. The government has introduced The Treasury Laws Amendment (2018 Superannuation Measures No 1) Bill 2018, which includes new non-arm’s-length income (NALI) provisions. Interestingly, it states these new provisions are needed to cater for the ambiguity in the current section 295-550 of the Income Tax Assessment Act 1997 in relation to expenses, capital gains and limited recourse borrowing arrangements (LRBA).
But what we have been given to amend the old NALI laws is very tough. I will cover the impact in a separate article in the future, but let me hand you an example from the explanatory memorandum to the bill.
Example 3.1: Non-arm’s-length expenses of a superannuation entity
An SMSF acquired a commercial property from a third party at its market value of $1 million on 1 July 2015. The SMSF derives rental income of $1500 per week from the property ($78,000 a year). The SMSF financed the purchase of the property under LRBAs from a related party on terms consistent with section 67A of the Superannuation Industry (Supervision) Act. The LRBAs were entered into on terms that include no interest, no repayments until the end of the 25-year term and borrowing of the full purchase price of the commercial real property (that is 100 per cent gearing). The SMSF was in a financial position to enter into LRBAs on commercial terms with an interest rate of about 5.8 per cent. The SMSF has not incurred expenses that it might have been expected to incur in an arm’s-length dealing in deriving the rental income. As such, the income that it derived from the non-arm’s-length scheme is non-arm’s-length income. The rental income of $78,000 (less deductions attributable to the income) therefore forms part of the SMSF’s non-arm’s-length component and is taxed at the highest marginal rate. However, there will be no deduction for interest, which under the scheme was nil. Non-arm’s-length interest on borrowings to acquire an asset will result in any eventual capital gain on disposal of the rental property being treated as non-arm’s-length income.
From here on in, any SMSF adviser needs to be asking with each external transaction, whether with an arm’s-length party or not (the law does not need two non-arm’s-length parties), does NALI apply to it, because if it does, income and capital gains are taxed at 45 per cent. Try explaining that to a client.