Got an SMSF? Watch out for schemes the ATO doesn’t like

As at 30 June 2022, there were over 603,000 self-managed superannuation funds (SMSF) in Australia. The investments in these funds made up around 26% of all superannuation monies invested. Around 5% of the adult population in Australia are members of SMSFs.

Superannuation funds are, broadly, taxed at a rate of 15% of their income. However, money invested in a superannuation fund, for the most part, is locked into the fund until a person retires. These two issues provide motivation for promoters of schemes to access the
low rate of tax and to provide access to the money held in the fund before retirement.

The Australian Taxation Office (ATO) has provided warnings about schemes that are being promoted to people that either have an existing SMSF or are being approached to set up an SMSF to enable access to superannuation monies before retirement.

Property development ventures

One scheme the ATO has issued a warning about relates to the use of SMSFs to invest in a property development in a manner that inflates the profits earned by the SMFSs when compared to the capital the SMSF commits to the venture.

There is nothing wrong with a SMSF investing in property ventures, provided the investments are entered into on a genuine arm’s-length basis. If investments are entered into with related parties, even though on an arm’s-length basis, care still needs to be taken.

In one scheme identified by the ATO, an arm’s length third party contracts with a company related to SMSFs to build a number of units or apartments. Those who control the SMSFs provide services to the company (which they control) and charge low fees to that
company. Also, loan capital is provided to the development company at a low or no interest rate.

The result is that the development company earns inflated profits. These profits (after the company pays tax on the profits) are then paid as fully franked dividends up a chain of companies to the SMSFs. The development company may have paid tax at a rate of 30% on the profits earned. When the profits reach the SMSF as fully franked dividends, the tax paid by the company is refunded to the extent of the SMSF only paying 15% on the profits.

The ATO says that this means the SMSF contravenes the superannuation and tax laws because the SMSF is earning “non-arm’s length income” (NALI). NALI earned by a superannuation fund is taxed at 45%. The SMSF may also be treated as a non-complying fund because it may have breached the “sole purpose” test. This means it will have lost all of its tax concessional status.

First home buyer scheme

Another scheme the ATO doesn’t like is one that involves first home buyers. It is a scheme for a first home buyer to use their existing superannuation savings in support of the purchase price of a home.

Broadly, a promoter of the scheme persuades a person with existing superannuation savings to set up their own SMSF and transfer their existing superannuation savings into the SMSF. The SMSF then invests in an unrelated unit trust. Due to this funds are then made available from another source to the individual to assist them with purchasing a home – for example the payment of a deposit.

The ATO doesn’t like this because it effectively enables the individual to access the benefit of their superannuation before their retirement. It also enables the SMSF to provide a benefit to a member.

Money attracts promoters

At 30 June 2022 there was $869 billion invested in SMSFs. This large amount of money – much of it “locked away” – provides a rich source of motivation for scheme promoters to sell to unsuspecting SMSF trustees and members ideas that fall foul of the law.
There are a variety of schemes that are being promoted. As the ATO warns, if it seems like it is too good to be true – it probably is.