In 1999 the regulation of SMSFs was moved from the Superannuation and Insurance Commission (subsequently APRA) to the Australian Taxation Office (ATO). At that time, it was suggested that the ATO acquired the role because SMSFs were seen to be just tax play vehicles, not serious retirement funding vehicles. So, in 2015 when SMSFs hold one-third of the $2 trillion or so in super, is it still correct to say that the ATO’s role in SMSFs is just revenue protection? Or does the ATO have a role in ensuring that SMSF members have a comfortable retirement?
Comparing ATO and APRA regulation
Our starting point has been to compare the way that the ATO regulates SMSFs with the way that APRA regulates the institutional super funds it is responsible for (retail, industry and corporate super funds for example) against five criteria.
First, we looked at the main rule which links the way that a super fund is managed with the tax concessions received on contributions, fund income and benefit taxes: that is, how to be a ‘complying superannuation fund’. The compliance test for SMSFs is different to that for the other type of super funds and, generally, it relates to ensuring that the assets of the SMSF are not misused, such as being a liquidity vehicle for a fund member who has an otherwise illiquid asset. What we also saw was that the chances of non-SMSFs falling foul of this rule are virtually zip.
Second, we looked at the ‘covenants’ in super fund trust deeds. Covenants are, in effect, standards of conduct by which the trustee must run the fund. Again, these differ between SMSFs and non-SMSFs and, importantly, the covenants applying to institutional funds are all directed at protecting the members of the fund from mismanagement by the trustee around various risks that members may be exposed to. On the other hand, the covenants by which a SMSF trustee must comply with relate again to protecting against misuse of the fund assets.
One important covenant for SMSFs is that at they have an ‘investment strategy’, which is referenced to things about investing such as having regard to asset/liability, liquidity and diversification. Interestingly, while the ATO will want to see the SMSF’s investment strategy that is about as far as they go. They do not comment on whether it is good or bad. They just want to see that one exists.
Third, we looked at any differences in the application of the ‘sole purpose test’ between the two types of super funds. It’s the principal regulatory tool for SMSFs and it comes from a 1967 High Court decision about whether a Western Sydney solicitor’s super fund, which was running a property development business, was in fact, a super fund (it wasn’t.) In any case, with two exceptions, all the cases on the sole purpose test have involved SMSFs. It’s not a relevant issue for non-SMSFs.
Fourth, we looked at the rules restricting how a super fund invests. Again, with two exceptions, these rules apply equally to both types of super fund, but what we see is that most of these restrictions are about related-party transactions, which is also not an issue for non-SMSFs.
Finally, we looked at the difference in the style of regulation between the ATO and APRA. This is very telling as the way the ATO regulates SMSFs is against breaches of black letter laws, which, necessarily, can only be done after the breach has occurred. On the other hand, APRA is a prudential principle-based regulator, which assesses the risks to members in the way that the super fund is being run and then offers guidance to the trustees about how to manage those risks. Of course, that is regulation in advance of a breach, besides being directed at protecting members’ interests.
SMSF regulation is simply to ensure qualification for tax concessions
Overall then, our preliminary view is that the ATO simply regulates SMSFs to ensure that they are used for the purposes for which they receive tax concessions. For example, all that is required of an ‘investment strategy’ is that it exists, with no opinion on whether 0% or 100% of anything is suitable.
The next stage for us is to compare SMSF regulation with equivalent type pension funds in the US, Canada and the UK, to see how they do it and why. Also, we will have a look at how some other tax preferred funding vehicles are regulated, such as venture capital funds.
So what? Why do we need to know how SMSFs are regulated? Well, they do hold around $600 billion in assets so it would seem sensible to understand how they are regulated and whether this is appropriate, just in case we can make some suggestions for improvement. For example, is it reasonable that there is no guidance given to the trustee of a super fund on how money should be invested?
Gordon Mackenzie is a Senior Lecturer in taxation and business law at the Australian School of Business, University of New South Wales.