ATO cracks down on SMSF cash reserves. Are you breaking the rules?

Written by John Maroney, CEO, SMSF Association

Published in the Financial Review on 20 June 2018

Trustees and their advisers need to be alert to the Australian Taxation Office’s tougher approach to the use of cash reserves in self-managed superannuation funds (SMSFs) after the government’s super reform measures announced in the 2016-17 budget.

The regulator has made it clear in its SMSF Regulator’s Bulletin (SMSFRB 2018/1) that there will be only limited circumstances in which SMSFs can use reserves, and it will be vigilant in ensuring their use does not circumvent the superannuation and income tax legislation.

In broad terms, reserves fall within the ATO’s guidelines if they are created for a specific and acceptable circumstance, and the purpose is consistent with the investment strategy and the discharge of fund liabilities as they fall due. The definition of a reserve is an amount of money set aside to meet a future contingency or demand on the fund.

For SMSFs, the regulator makes it clear that most purposes for which reserves may be created are inconsistent with and inappropriate for SMSFs. Investment reserves, pension reserves for account-based pensions, self-insurance reserves and administration reserves are listed as examples of inappropriate reserves for SMSFs.

However, not all amounts that are set aside and not allocated to members are reserves.

It is recognised that unallocated monies such as suspense accounts created to record contributions not yet allocated to members are not reserves. This treatment of contributions received and not yet allocated to members in this way is considered appropriate for SMSF trustees.

Further, pre-existing July 1, 2017 anti-detriment reserves will typically get the ATO’s seal of approval provided they are permitted under Section 115 of the Superannuation Industry (Supervision) Act 1993 (SIS Act) and they have not been set up to circumvent the July 1 changes. It would be expected that these reserves would be progressively allocated to members as appropriate over time, as anti-detriment payments are generally not available to be paid in relation to members who pass away on or after July 1, 2017.

When caution is needed
So what will raise the eyebrows of the ATO?

As the regulator states in its bulletin, its concerns are both regulatory and ensuring trustees comply with the changes that took effect on July 1, 2017, particularly as they relate to the $1.6 million transfer balance cap (TBC) and total superannuation balance (TSB).

On the regulatory front, the ATO cites three key concerns:

  • Reserves must have a clearly defined purpose and must not be expressly prohibited under the trust deed of the SMSF.
  • Reserves must always comply with the sole purpose test, better known as the retirement purpose test. This extends to all SMSF activities, including acquiring and investing fund assets, employing and using fund assets and paying benefits.
  • Trustees must adhere to paragraph 52B(2)(g) of the SIS Act that requires them to devise, review regularly and implement a strategy for the prudential management of reserves consistent with the fund’s investment strategy and its capacity to discharge liabilities.

The July 1, 2017 changes are also front of mind for the ATO, with the Bulletin stating there are four types of arrangements that it will closely run the ruler over:

  • Deliberately using a reserve to reduce a member’s total superannuation balance to enable them to make non-concessional contributions without breaching their non-concessional contributions’ cap.
  • Deliberately using a reserve to reduce a member’s total superannuation balance below $500,000 to allow the member to access the catch-up concessional contributions arrangements.
  • Deliberately using a reserve to reduce the balance of a member’s transfer balance account to allow the member to allocate a greater amount to retirement phase and thereby have a greater amount of earnings within the SMSF exempt from current pension income.
  • Deliberately using a reserve to reduce a member’s total superannuation balance below $1.6 million to allow the SMSF to use the segregated method to calculate its exempt current pension income.

Any suggestion that reserves have been used inappropriately in these circumstances (such that the regulator considers that a scheme has been entered into to achieve tax benefits) will potentially attract the anti-tax avoidance provisions of the Income Tax Assessment Act.

So trustees of SMSFs must be extremely careful when dealing with existing reserves accrued before July 1, 2017 and sceptical of any investment arrangements proposed to them involving the creation of new reserves in their SMSF.

The regulator has made its position clear that in most cases, reserves are not appropriate for SMSFs and that the purposes for which reserves may be used in this context may well attract the operation of the anti-tax avoidance provisions. Such unwelcome attention by the regulator is usually best avoided, a fact SMSF trustees should be mindful of, should they be considering their use.