Docstoc

Session 1A_ The Latest in Reserving Strategies

Document Sample
Session 1A_ The Latest in Reserving Strategies Powered By Docstoc
					                Session 1A:
The Latest in Reserving Strategies

          Robert O’Donohue
        Partner, HWL Ebsworth Lawyers




                                        2011 SMSF National Conference
When can an SMSF use a reserve?
 Section 115 of SIS Act - Trustee may maintain reserves
  unless governing rules prohibit

 Broad administrative powers in most trust deeds

 Ideally, trust deed specifies power to create reserve
  and details what types of reserves may be created

 If unsure trustee should seek legal advice
                                        2011 SMSF National Conference
What must you do in creating and maintaining
reserves?
 Section 52(2)(g) of SIS Act – Trustee agrees to formulate and give
  effect to strategy for prudential management consistent with
  investment strategy and capacity to discharge liabilities
 Defence to an action for loss (s.55(6))
 Strategy should state:
      purpose of reserve
      target level of funds for purpose
      how funds invested (refer to fund inv strategy)
      policy as to distributions
      intervals for review


                                                         2011 SMSF National Conference
How are distributions treated for tax purposes?
 General Rule - distributions from reserves are concessional
  contributions unless:

   1) allocated in a “fair and reasonable” manner to every member (or
      class of members) and

   2) Together with other distributions for financial year (if any), less than 5%
      of member’s account at time of distribution

 If 1 and 2 above satisfied distribution is neither a concessional, nor
  a non-concessional contribution


                                                        2011 SMSF National Conference
How are distributions treated for tax purposes?
• Rule does not apply to two reserves:

   – Distributions from Contributions Reserves

        amount allocated from contributions reserve generally retains character
         of contribution made to fund i.e. concessional or non-concessional
         contribution

   – Distributions from Pension Reserves

        to allow for pension commutations, pension payments and death benefits
         greater than 5% of members account


                                                        2011 SMSF National Conference
When is a distribution “fair and reasonable”?
 Explanatory Statement to ITAR 1997:

     “In determining what is fair and reasonable...it would ordinarily be
     expected that the allocation would be in proportion to the existing
     interests of the members so that particular members are not favoured
     over others”

 ATO in NTLG Superannuation Tech. Subgroup meeting of 8
  September 2009
     “To be fair and reasonable the Tax Office considers that the
     allocation of an amount from a reserve should be allocated to each
     member’s interest in proportion to that interest in the superannuation
     fund”


                                                    2011 SMSF National Conference
When is a distribution “fair and reasonable”?
 APRA agrees with ATO
 Proportionate approach can lead to unfair results:
  Example
    Tom has a $1 million account in his family SMSF
    Tom’s wife Katie has a $100,000 account
    Trustee has retained $1,000 p.a. from each of them in an Expense
     Reserve to administer the fund
    If the trustee distributes any surplus from the Expense Reserve back to
     Tom and Katie in proportion to their accounts Tom must receive 10 x
     Katies distribution for it to be considered “fair and reasonable”
 Need clearer regulatory guidance


                                                     2011 SMSF National Conference
How are reserves treated for super benefit purposes?

 Accumulation members
   If up to 5% limit and fair and reasonable
     o taxable component because not a contribution

   If 5% or above or unfair or unreasonable
     o arguably part of tax free component because deemed a
       “concessional contribution” and because not assessable in fund
       could form part of tax free component

     o Critical issue – whether deemed concessional contributions are
       “contributions” – not defined in ITAA or ITAR


                                                 2011 SMSF National Conference
How are reserves treated for super benefit purposes?

     o ATO considers that deemed concessional contributions are not to
       be regarded as ‘contributions’ because do not increase the
       capital of the fund (NTLG Superannuation Technical Sub-Group
       meeting of 8 September 2009)


     o Therefore ATO view is that deemed concessional contributions
       comprise taxable component of a members interest.


  – This means all reserve distributions form taxable component of
    accumulation members unless a Court determines otherwise


                                                2011 SMSF National Conference
How are reserves treated for super benefit purposes?

 Pensioners
   ATO confirmed allocations of reserves to pensioners will be
    comprised of the same proportions as the components of the
    pension when the pension commenced (NTLG Super
    Technical Sub-group Meeting of September 2009)




                                            2011 SMSF National Conference
So what is a reserve?
 Seems no-one is entirely sure but crucial definition

 No definition in SIS Act, ITAA or ITAR despite references

 SIS Regulations definition meaningless

 APRA and ASIC
    Acknowledge no definition
    APRA – “reserves in superannuation funds can be regarded as
     monies which form part of the net assets of a fund and which have
     been set aside for a clearly stated purpose” (Draft Prudential Practice
     Guide - SPG 235 – Use of Reserves in Superannuation Funds)


                                                    2011 SMSF National Conference
So what is a reserve?
         APRA excludes ‘suspense accounts’ used to record contributions,
          provisions for administration expenses, tax, management or service
          provider fees
         APRA view nonsensical – if contributions ‘suspense account’ is not a
          reserve why does it need to be exempted from the rules relating to
          distributions from reserves in ITAR?
         APRA & ASIC distinguish between a reserve and a provision. Reserves are
          amounts for contingencies, provisions are for specific obligations from past
          events i.e. tax expense

 ATO
   SCR 1999/1 – Commissioner deems any “unallocated amounts” as
    reserves being the excess of the net market value of assets over
    members accounts


                                                           2011 SMSF National Conference
So what is a reserve?
   Much broader than APRA and ASIC
   Divided unallocated surplus amounts into three general
    reserves:
     o Investment Reserve
     o Contribution Reserve
     o Miscellaneous Reserve


 Need clear legislative/regulator guidance on what a
  reserve is


                                            2011 SMSF National Conference
What is the maximum amount allowed in reserves?
   SIS legislation – no maximum stipulated

   APRA and ASIC – any excess over amount required for purpose of
    reserve should be allocated to members

   Competing obligations – requirement to distribute excess reserves v. best
    interest of members not to incur excess contributions tax

   Need regulatory guidance

   ATO indicate 15% maximum for investment fluctuation reserve in SCR
    1999/1



                                                      2011 SMSF National Conference
What reserving strategies are available to SMSFs?

• Contributions Reserve
   Used to hold contributions until allocated to member’s
    account
   Must allocate to member within 28 days after month when
    contribution received (SIS Regulation 7.08(2))
   Strategy available because of defect in ITAA 97
   S 292-90 of ITAA 97 – non concessional conts = conts made for
    a person not included in income of fund PLUS any amount
    allocated in accordance with regulations
   This includes amounts distributed from a contributions reserve


                                              2011 SMSF National Conference
Contributions Reserve Cont’d
 Technically counted as non-concessional cont twice:
    Once when contributed to fund; and
    Secondly when allocated from contributions reserve

 ATO have agreed to count only once when distribution made
  from the Contributions Reserve if done within SIS Reg timeframe
  (ignores 1 month timeframe in s 1017E of Corps Act)

 Means contributions can be made on 1 June of financial year but
  not counted for cap until following financial year when allocated
  by 28 July

                                                 2011 SMSF National Conference
Contributions Reserve Cont’d
 Case Study - Useful for in specie contributions

                                                               B+H
         
                                 property                    Super Fund

 1.   Bill & Hillary contribute commercial property to their SMSF on 15 June 2011
      ($1.3 Million M.V.)
 2.   2010/11 - Non-concessional caps - $300k counted ($150k each);
              - Concessional caps - $100k (50k each)
 3.   Remaining portion held in contributions reserve and allocated to member
      accounts on 15 July 2011
 4.   2011/12 - Non-concessional cap – 900k ($450k each) (bring forward rule)


                                                          2011 SMSF National Conference
Contributions Reserve Cont’d
 Case Study - Useful for managing cap overflows
   George’s employer contributes his super under a salary
    sacrifice arrangement each year up to the conc. cap
   Agreed with employer that this will be done on 28 September,
    28 December, 28 March and 28 June
   At the end of 2010/11, it is realised that George’s employer
    paid the June 2010 contribution late in July 2010
   The contributions received by the fund in 2010/11 for George
    are therefore $6,250 more than the 25k cap


                                            2011 SMSF National Conference
Contributions Reserve Cont’d
 Utilising the contributions reserve the trustee of Georges SMSF
  retains the June 2011 contribution in a contributions reserve and
  allocates it to George’s account in July 2011

 This prevents George from breaching the concessional
  contributions cap for 2010/11 because the excess is allocated to
  2011/12 year

 Faster and easier than getting Commissioner discretion



                                                2011 SMSF National Conference
Self Insurance Reserves
 Used to fund salary continuance, death and TPD benefits

 SMSF essentially self insures members – pay proceeds to member
  if event occurs

 Actuary should determine level of reserves required to fund claims
  (annual review)

 Is reserve subject to 5% rule? No exception so technically, it
  appears so (March 2010 NTLG Super meeting) – watch this space


                                               2011 SMSF National Conference
Self Insurance Reserves Cont’d
 Why self insure?
    Some members can’t be insured externally or terms of insurance too
     restrictive

    Fund can claim a tax deduction for either
       1. insurance premiums reasonably expected to otherwise pay (actuarial
          opinion required); or
       2. Amount of benefits paid where event occurs x members future service
          days (eg to age 65)/total service period (once chosen this option applies
          to all future years)

    Death and TPD insurance not deductible outside of super


                                                          2011 SMSF National Conference
Anti-detriment Reserves
 Used to pay out “anti-detriment” benefit
 These are an additional payment made by fund on top of death
  benefit to compensate for contributions tax paid by deceased
 Benefit is a lump sum reflecting extra amount that would have
  been paid had contributions tax not been payable
 Fund effectively refunded benefit paid due to tax saved from tax
  deduction
 Payment must be made first to get deduction so creates cash-
  flow issue and therefore need reserve in an SMSF



                                              2011 SMSF National Conference
Anti-detriment Reserves Cont’d
 Caution needed - September 2009 & March 2010 NTLG Super
  Technical Sub-group Meeting - ATO confirm anti-detriment
  payment will be a concessional contribution if funded from
  reserve b/c generally more than 5% of members account

 ATO approach could mean excess contributions tax payable on
  distribution at 31.5% (possibly 78% if non-conc. cap exceeded)

 ATO consulting with APRA on the issue

 Possibly use Pension Reserve to avoid b/c not subject to 5% rule or
  possibly use “provision” rather than “reserve”?

                                                2011 SMSF National Conference
Investment Fluctuation Reserves
 Used by funds to “smooth” investment returns on a year-to-year
  basis

 Example
    Investment objective = earnings of CPI + 2% pa
    To meet objective trustee retains 2% in IFR in years when fund earns
     CPI + 4%
    Extra 2% distributed to accounts from IFR in years when only CPI
     earned by fund

 Superannuation Contributions Ruling SCR 1999/1 – should be
  limited to 15% of fund


                                                    2011 SMSF National Conference
Investment Fluctuation Reserves Cont’d
 In distributing need to have regard to equity between
  members i.e. exited members may be paid further
  amount if reserve wound-up to compensate for time in
  fund

 Should be careful if distribute 5% or more




                                         2011 SMSF National Conference
Pension Reserves
 Holds “segregated current pension assets” to support pension
  liabilities

 Actuarial certificate required to determine assets required

 Tax exempt (unless non arms-length) and allocations not
  concessional contributions if used to pay pension, rollover to
  another pension or fund a death benefit (reg 292-25.01(4)(b) of
  ITAR)

 Very useful for funds with assets with large uncrystallised CGT
  liabilities

                                                 2011 SMSF National Conference
Pension Reserves Cont’d
Case Study – managing CGT liabilities
• John and Janette SMSF - $4 million ($2 million equities,
  $2 million commercial property)
• Equities - $1.5 million capital gain, Property – no gain
• John 65 – wants to start an account based pension
• Trustee decides to segregate equities to support
  John’s pension – no CGT payable when shares sold


                                         2011 SMSF National Conference
Pension Reserves Cont’d

 ATO indicated that pension accounts may be
  “topped up” from distributions from reserves (NTLG
  Superannuation Sub-Committee Meeting - Sept 2009)

 Reserve distributions added to pension account are in
  same tax free/taxable proportions as pension itself

 Creates planning opportunities

                                       2011 SMSF National Conference
Pension Accounts and Reserves
Case Study – managing tax components
 Brad and his partner Angelina are 55 and have their own SMSF
 Fund = $2.3 million in assets
 Brad’s Account = Tax free - $900,000
                      Taxable - $100,000
 Ang’s Account = Tax free - $950,000
                     Taxable - $50,000
 IFR = $300,000



                                             2011 SMSF National Conference
Pension Accounts and Reserves Cont’d
 Both Brad and Ang decide to commence TRIS’s

 After commencing pensions trustee decides to wind-up the 300k
  Investment Fluctuation Reserve and distribute it over a 3.5 year
  period (to prevent breaching 5% limit)

Result
 Brad - $135,000 is added to his pension account as tax free
  component, 15k added as taxable component

 Ang - $142,500 added as tax free component, $7,500 as taxable
  component

                                               2011 SMSF National Conference
Pension Accounts and Reserves Cont’d
 If the trustee had decided to wind-up the IFR in the
  accumulation phase (or distribute earnings directly)
  the whole $300,000 would have been taxable
  component (compared to just $22,500 whilst in
  pension phase)

 ROT – always better to distribute from reserves when
  members in pension phase


                                        2011 SMSF National Conference
Other Reserves
 Expense Reserve – for administration expenses including
  accounting and legal fees, investment management fees,
  insurance and other expenses

 In-house Assets Reserve – allows trustee to observe total in-house
  assets at a glance

 Forfeiture reserve – generally only utilised by SMSFs with defined
  benefit pensions such as lifetime pensions where no RCV after
  member dies. Capital supporting pension re-allocated within the
  fund.

                                                2011 SMSF National Conference
Asset Protection
 Amounts in reserves (apart from a Contributions
  Reserve or Pension Reserve) more likely to be
  protected from family law claims as such amounts do
  not comprise a member’s superannuation “interest”
  for family law purposes

 Investment fluctuation reserve, expense reserve, anti-
  detriment reserve and self-insurance reserve may assist
  in this respect


                                        2011 SMSF National Conference
Conclusion
 Reserves may be utilised for:
      Managing excess contributions
      Smoothing investment returns
      Eliminating potential CGT liabilities
      Managing tax components
      Insuring members who may not otherwise be insurable
      Accessing anti-detriment payments
      Asset protection

 Residual issues - What is a reserve? What is a fair and reasonable
  distribution? Requirement to distribute surplus reserves v. potential
  conc. contributions if 5% or more? 5% rule and certain reserves?


                                                  2011 SMSF National Conference

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:1
posted:10/25/2012
language:English
pages:34