“You will be haunted,” resumed the Ghost, “by three spirits.”
Scrooge’s countenance fell, almost as low as the Ghost’s had done.
”Is that the chance and favor that you mentioned, Jacob?” he demanded in a faultering voice.
”I—I think I’d rather not,” said Scrooge.
”Without their visits,” said the Ghost, “you cannot hope to shun the path I tread.””
— Charles Dickens. “Compliance for Dummies”
GIFTS FOR YOUR CHRISTMAS STOCKING
‘Tis the season to be jolly… fun, frivolity and festivities … but as the new year dawns and advisers venture back into the office, so too will our regular remit of reviewing SMSF files, identifying areas of concern, and responding to adviser and Licensee questions.
Providing personal financial advice to the trustee or members of a self managed super fund is inevitably going to require a clear-eyed approach from the adviser:
- “Personal advice” and “self managed” can in some senses be the antithesis of each other;
- This can cause confusion for both adviser and client(s).
In this article, as an early gift for your Christmas stocking (or non-specific festive season gift pack if that’s your preferred nomenclature), we examine three common issues with SMSF advice.
There is still just enough time to repackage the article and regift it (subject to intellectual property law of course) … but we recommend you read it first as Santa just may have something of benefit for you!
WHO IS THE CLIENT?
We are often asked questions such as:
- Is the SMSF trustee the client? Or the SMSF members? Or both?
- Do we need two Statements of Advice (SOAs) for this advice, or is one SOA addressed to both the trustee and members sufficient?
- Should we address the SOA to the Directors of the Corporate Trustee?
These questions conceal a deeper issue – which is that establishing the client(s) you are providing advice to is crucial in identifying the subject matter of the advice.
A good starting point is to read AFCA’s factsheet on SMSF complaints.
This explains when the complainant is a trustee, and when it is an individual. For example, investment advice is typically provided to the trustee(s), whereas contributions, rollover, or SMSF commencement advice is provided to individuals. Insurance advice may need to be addressed to both trustee(s) and member(s).
Clarifying the client(s) enables both adviser and client to understand and agree on an appropriate scope of advice:
- ASIC INFO 267 is clear in this regard, stating that “when giving limited advice, you need to clearly communicate the advice you are providing and the advice you are not providing, and the implications of this.”
- Clearly noting the client(s) also makes it easier to apportion advice fees in a manner compliant with the superannuation sole purpose test, and to allocate ongoing advice to the correct entity(ies).
A case in point is superannuation contributions advice:
- If it is clear this is being provided to a member, rather than a trustee, it reinforces the importance of an adviser seeking to obtain relevant contributions history for the client, which may in some circumstances need to include all contributions to superannuation that the client has made over the past three financial years.
- We regularly see files where advisers rely on superannuation contributions histories disclosed by client – but ASIC INFO 267 indicates that advisers need to make their “own enquiries” to ensure “relevant information is not overlooked”.
- In the context of SMSFs, where financial information can be hard to obtain due to delays in financial statements, and members can be independently minded by nature, it is important not to take unreasonable data gathering shortcuts.
Note that improperly demarcating the client(s) and the scope of advice is a catalyst that leads to or exacerbates other subsequent errors:
- ASIC have banned advisers for (among other things) limiting superannuation advice to exclude insurance advice where the insurance advice was nonetheless critical to the advice being provided.
- Given that an SMSF investment strategy must consider insurance, correctly identifying an SMSF trustee as a client and then reviewing the investment strategy in relation to the advice being provided is a good starting point for ensuring critical issues are not missed.
- Ensure the Statement of Advice (SOA) and engagement letter/agreement explicitly identifies the clients under advice.
- Consider whether it is appropriate or necessary for advice to be provided separately to different clients – for example with one SOA providing advice to clients in their individual capacity and one to the trustee(s) of the SMSF.
THE PRODUCT IS NOT THE ANSWER
A review of recent AFCA case determinations yields informative examples of complaints about advice recommending clients set an SMSF and utilise a limited recourse borrowing arrangement (LRBA) to purchase direct property.
One key recurring issue is advisers confusing a product with an objective:
- Advisers sometimes take the view that a client wanting to set up an SMSF to have better control over investment options in super, and to purchase an investment property in an SMSF using gearing, is an objective.
- AFCA demonstrably takes an opposing view – for example in Determination 853308, and in 853243, the latter of which states that “the acquisition of real property for investment purposes is not an ‘objective’, it is a means by which an objective may be achieved.”
Another key issue is scope of advice: in Determination 853308[, AFCA explained that advice to establish an SMSF in order to purchase direct property could not scope out borrowing and debt because it was an implicit and critical aspect of advice being provided. The Determination also outlines that the recommendation was been made without sufficiently understanding the client’s retirement objectives in quantitative terms (e.g. “retiring on X dollars per annum in Year Y”).
The key point is that clients may have clear preferences towards direct property and the client and adviser may wish to restrict the scope of advice, but this does not mean focusing on a product solution (e.g. setting up an SMSF to purchase a direct property) is sufficient. The fact the fund will be “self managed” does not remove the need to meet the Best Interests Duty.
- Do not mistake a client’s desire to purchase an investment property for a financial objective.
- Be very careful not to scope out subjects critical to the advice being provided.
CASH OUT RE-CONTRIBUTION STRATEGIES
SMSFs in some respects provide flexibility and versatility to clients, and advice may therefore at times have a strategic or tax planning focus, but this still needs to overlay with actual product considerations.
When it comes to “re-contribution strategies” aimed at reducing the taxable components of a member’s benefit, for example, the compliance key is found in an informal name of the strategy – a “cash out re-contribution”.
The ATO has indicated that journal entries are not sufficient when it comes to changing the characteristics of a member’s taxable and non-taxable benefits. The cash actually has to be withdrawn from the SMSF (either as a cash pension income payment, or a cash or in specie lump sum withdrawal).
Below is an example scenario we have encountered:
- SMSF with $990,000 in a commercial property and $10,000 in cash, with two members with equal account balances (90% taxable component for both);
- Strategic advice only being provided (no product advice);
- The recommendation is for both members to first withdraw and then recontribute $109,000 each during the current financial year (within the relevant non-concessional contribution cap).
One issue with the above is clear:
- There is insufficient cash in the SMSF bank account to enact the strategy as written, and it is not possible to in specie transfer 10% of a commercial property out from and then contribute it back into the SMSF.
Without getting into specifics – such as member age, access to cash, and breakdown of accounts in the SMSF between pension and accumulation phase – the key message is that the SOA and file needs to document the intended flow of funds, and sufficiently explain how the mechanics of the recommended strategy will be enacted.
- SMSFs do in some instances allow for much more flexibility than retail superannuation funds but that does not mean the details can be left to journal entry adjustments at a later date.
- Communication with external professionals (e.g. accountants, SMSF administration service) is often vital and needs to be documented on the file.