Trusts 101 – A Guide to What They are and How They Work in Australia


With all the talk about Total Super Balance caps and where people will invest money going forward if they can’t get it in to superannuation, the spotlight is being shone on “trusts” at present. This has also brought with it the claims of tax avoidance or tax minimisation, so what exactly are trusts and are there differences between Family Trusts, Units Trusts, Discretionary Trusts and Testamentary Trusts to name a few.

Trusts are a common strategy and this article aims to aid a better understanding of how a trust works, the role and obligations of a trustee, the accounting and income tax implications and some of the advantages and pitfalls. Of course, there is no substitute for specialist legal, tax and accounting advice when a specific trust issue arises and the general information in this article needs to be understood within that context.

Introduction

Trusts are a fundamental element in the planning of business, investment and family financial affairs. There are many examples of how trusts figure in everyday transactions:

  • Cash management trusts and property trusts are used by many people for investment purposes
  • Joint ventures are frequently conducted via unit trusts
  • Money held in accounts for children may involve trust arrangements
  • Superannuation funds are trusts
  • Many businesses are operated through a trust structure
  • Executors of deceased estates act as trustees
  • There are charitable trusts, research trusts and trusts for animal welfare
  • Solicitors, real estate agents and accountants operate trust accounts
  • There are trustees in bankruptcy and trustees for debenture holders
  • Trusts are frequently used in family situations to protect assets and assist in tax planning.

Although trusts are common, they are often poorly understood.

What is a trust?

A frequently held, but erroneous view, is that a trust is a legal entity or person, like a company or an individual. But this is not true and is possibly the most misunderstood aspect of trusts.

A trust is not a separate legal entity. It is essentially a relationship that is recognised and enforced by the courts in the context of their “equitable” jurisdiction. Not all countries recognise the concept of a trust, which is an English invention. While the trust concept can trace its roots back centuries in England, many European countries have no natural concept of a trust, however, as a result of trade with countries which do recognise trusts their legal systems have had to devise ways of recognising them.

The nature of the relationship is critical to an understanding of the trust concept. In English law the common law courts recognised only the legal owner and their property, however, the equity courts were willing to recognise the rights of persons for whose benefit the legal holder may be holding the property.

Put simply, then, a trust is a relationship which exists where A holds property for the benefit of B. A is known as the trustee and is the legal owner of the property which is held on trust for the beneficiary B. The trustee can be an individual, group of individuals or a company. There can be more than one trustee and there can be more than one beneficiary. Where there is only one beneficiary the trustee and beneficiary must be different if the trust is to be valid.

The courts will very strictly enforce the nature of the trustee’s obligations to the beneficiaries so that, while the trustee is the legal owner of the relevant property, the property must be used only for the benefit of the beneficiaries. Trustees have what is known as a fiduciary duty towards beneficiaries and the courts will always enforce this duty rigorously.

The nature of the trustee’s duty is often misunderstood in the context of family trusts where the trustees and beneficiaries are not at arm’s length. For instance, one or more of the parents may be trustees and the children beneficiaries. The children have rights under the trust which can be enforced at law, although it is rare for this to occur.

 

Types of trusts

In general terms the following types of trusts are most frequently encountered in asset protection and investment contexts:

  • Fixed trusts
  • Unit trusts
  • Discretionary trusts – Family Trusts
  • Bare trusts
  • Hybrid trusts
  • Testamentary trusts
  • Superannuation trusts
  • Special Disability Trusts
  • Charitable Trusts
  • Trusts for Accommodation – Life Interests and Rights of Residence

A common issue with all trusts is access to income and capital. Depending on the type of trust that is used, a beneficiary may have different rights to income and capital. In a discretionary trust the rights to income and capital are usually completely at the discretion of the trustee who may decide to give one beneficiary capital and another income. This means that the beneficiary of such a trust cannot simply demand payment of income or capital. In a fixed trust the beneficiary may have fixed rights to income, capital or both.

Fixed trusts

In essence these are trusts where the trustee holds the trust assets for the benefit of specific beneficiaries in certain fixed proportions. In such a case the trustee does not have to exercise a discretion since each beneficiary is automatically entitled to his or her fixed share of the capital and income of the trust.

Unit trusts

These are generally fixed trusts where the beneficiaries and their respective interests are identified by their holding “units” much in the same way as shares are issued to shareholders of a company.

The beneficiaries are usually called unitholders. It is common for property, investment trusts (eg managed funds) and joint ventures to be structured as unit trusts. Beneficiaries can transfer their interests in the trust by transferring their units to a buyer.

There are no limits in terms of trust law on the number of units/unitholders, however, for tax purposes the tax treatment can vary depending on the size and activities of the trust.

Discretionary trusts – Family Trusts

These are often called “family trusts” because they are usually associated with tax planning and asset protection for a family group. In a discretionary trust the beneficiaries do not have any fixed interests in the trust income or its property but the trustee has a discretion to decide whether anyone will receive income and/or capital and, if so, how much.

For the purposes of trust law, a trustee of a discretionary trust could theoretically decide not to distribute any income or capital to a beneficiary, however, there are tax reasons why this course of action is usually not taken.

The attraction of a discretionary trust is that the trustee has greater control and flexibility over the disposition of assets and income since the nature of a beneficiary’s interest is that they only have a right to be considered by the trustee in the exercise of his or her discretion.

Bare trusts

A bare trust exists when there is only one trustee, one legally competent beneficiary, no specified obligations and the beneficiary has complete control of the trustee (or “nominee”). A common example of a bare trust is used within a self-managed fund to hold assets under a limited recourse borrowing arrangement.

Hybrid trusts

These are trusts which have both discretionary and fixed characteristics. The fixed entitlements to capital or income are dealt with via “special units” which the trustee has power to issue.

Testamentary trusts

As the name implies, these are trusts which only take effect upon the death of the testator. Normally, the terms of the trust are set out in the testator’s will and are often used when the testator wishes to provide for their children who have yet to reach adulthood or are handicapped.

Superannuation trusts

All superannuation funds in Australia operate as trusts. This includes self-managed superannuation funds.

The deed (or in some cases, specific acts of Parliament) establishes the basis of calculating each member’s entitlement, while the trustee will usually retain discretion concerning such matters as the fund’s investments and the selection of a death benefit beneficiary.

The Federal Government has legislated to establish certain standards that all complying superannuation funds must meet. For instance, the “preservation” conditions, under which a member’s benefit cannot be paid until a certain qualification has been reached (such as reaching age 65), are a notable example.

Special Disability Trusts

Special Disability Trusts allow a person to plan for the future care and accommodation needs of a loved one with a severe disability. Find out more in this Q & A about Special Disability Trusts.

Charitable Trusts

You may wish to provide long term income benefit to a charity by providing tax free income from your estate, rather than giving an immediate gift. This type of trust is effective if large amounts of money are involved and the purpose of the gift suits a long term benefit e.g. scholarships or medical research.

Trusts for Accommodation – Life Interests and Right of Residence

A Life Interest or Right of Residence can be set up to provide for accommodation for your beneficiary. They are often used so that a family member can have the right to live in the family home for as long as they wish. These trusts can be restrictive so it is particularly important to get professional advice in deciding whether such a trust is right for your situation.

Establishing a trust

Although a trust can be established without a written document, it is preferable to have a formal deed known as a declaration of trust or a deed of settlement. The declaration of trust involves an owner of property declaring themselves as trustee of that property for the benefit of the beneficiaries. The deed of settlement involves an owner of property transferring that property to a third person on condition that they hold the property on trust for the beneficiaries.

The person who transfers the property in a settlement is said to “settle” the property on the trustee and is called the “settlor”.

In practical terms, the original amount used to establish the trust is relatively small, often only $10 or so. More substantial assets or amounts of money are transferred or loaned to the trust after it has been established. The reason for this is to minimise stamp duty which is usually payable on the value of the property initially affected by the establishing deed.

The identity of the settlor is critical from a tax point of view and it should not generally be a person who is able to benefit under the trust, nor be a parent of a young beneficiary. Special rules in the tax law can affect such situations.

Also critical to the efficient operation of a trust is the role of the “appointor”. This role allows the named person or entity to appoint (and usually remove) the trustee, and for that reason, they are seen as the real controller of the trust. This role is generally unnecessary for small superannuation funds (those with fewer than five members) since legislation generally ensures that all members have to be trustees.

The trust fund

In principle, the trust fund can include any property at all – from cash to a huge factory, from shares to one contract, from operating a business to a single debt. Trust deeds usually have wide powers of investment, however, some deeds may prohibit certain forms of investment.

The critical point is that whatever the nature of the underlying assets, the trustee must deal with the assets having regard to the best interests of the beneficiaries. Failure to act in the best interests of the beneficiaries would result in a breach of trust which can give rise to an award of damages against the trustee.

A trustee must keep trust assets separate from the trustee’s own assets.

The trustee’s liabilities

A trustee is personally liable for the debts of the trust as the trust assets and liabilities are legally those of the trustee. For this reason if there are significant liabilities that could arise a limited liability (private) company is often used as trustee.

However, the trustee is entitled to use the trust assets to satisfy those liabilities as the trustee has a right of indemnity and a lien over them for this purpose.

This explains why the balance sheet of a corporate trustee will show the trust liabilities on the credit side and the right of indemnity as a company asset on the debit side. In the case of a discretionary trust it is usually thought that the trust liabilities cannot generally be pursued against the beneficiaries’ personal assets, but this may not be the case with a fixed or unit trust.

Powers and duties of a trustee

A trustee must act in the best interests of beneficiaries and must avoid conflicts of interest. The trustee deed will set out in detail what the trustee can invest in, the businesses the trustee can carry on and so on. The trustee must exercise powers in accordance with the deed and this is why deeds tend to be lengthy and complex so that the trustee has maximum flexibility.

Who can be a trustee?

Any legally competent person, including a company, can act as a trustee. Two or more entities can be trustees of the same trust.

A company can act as trustee (provided that its constitution allows it) and can therefore assist with limited liability, perpetual succession (the company does not “die”) and other advantages. The company’s directors control the activities of the trust. Trustees’ decisions should be the subject of formal minutes, especially in the case of important matters such as beneficiaries’ entitlements under a discretionary trust.

Trust legislation

All states and territories of Australia have their own legislation which provides for the basic powers and responsibilities of trustees. This legislation does not apply to complying superannuation funds (since the Federal legislation overrides state legislation in that area), nor will it apply to any other trust to the extent the trust deed is intended to exclude the operation of that legislation. It will usually apply to bare trusts, for example, since there is no trust deed, and it will apply where a trust deed is silent on specific matters which are relevant to the trust – for example, the legislation will prescribe certain investment powers and limits for the trustee if the deed does not exclude them.

Income tax and capital gains tax issues

Because a trust is not a person, its income is not taxed like that of an individual or company unless it is a corporate, public or trading trusts as defined in the Income Tax Assessment Act 1936. In essence the tax treatment of the trust income depends on who is and is not entitled to the income as at midnight on 30 June each year.

If all or part of the trust’s net income for tax purposes is paid or belongs to an ordinary beneficiary, it will be taxed in their hands like any other income. If a beneficiary who is entitled to the net income is under a “legal disability” (such as an infant), the income will be taxed to the trustee at the relevant individual rates.

Income to which no beneficiary is “presently entitled” will generally be taxed at highest marginal tax rate and for this reason it is important to ensure that the relevant decisions are made as soon as possible after 30 June each year and certainly within 2 months of the end of the year. The two month “period of grace” is particularly relevant for trusts which operate businesses as they will not have finalised their accounts by 30 June. In the case of discretionary trusts, if this is done the overall amount of tax can be minimised by allocating income to beneficiaries who pay a relatively low rate of tax.

The concept of “present entitlement” involves the idea that the beneficiary could demand immediate payment of their entitlement.

It is important to note that a company which is a trustee of a trust is not subject to company tax on the trust income it has responsibility for administering.

In relation to capital gains tax (CGT), a trust which holds an asset for at least 12 months is generally eligible for the 50% capital gains tax concession on capital gains that are made. This discount effectively “flows” through to beneficiaries who are individuals. A corporate beneficiary does not get the benefit of the 50% discount. Trusts that are used in a business rather than an investment context may also be entitled to additional tax concessions under the small business CGT concessions.

Since the late 1990s discretionary trusts and small unit trusts have been affected by a number of highly technical measures which affect the treatment of franking credits and tax losses. This is an area where specialist tax advice is essential.

Why a trust and which kind?

Apart from any tax benefits that might be associated with a trust, there are also benefits that can arise from the flexibility that a trust affords in responding to changed circumstances.

A trust can give some protection from creditors and is able to accommodate an employer/employee relationship. In family matters, the flexibility, control and limited liability aspects combined with potential tax savings, make discretionary trusts very popular.

In arm’s length commercial ventures, however, the parties prefer fixed proportions to flexibility and generally opt for a unit trust structure, but the possible loss of limited liability through this structure commonly warrants the use of a corporate entity as unitholder ie a company or a corporate trustee of a discretionary trust.

There are strengths and weaknesses associated with trusts and it is important for clients to understand what they are and how the trust will evolve with changed circumstances.

Trusts which incur losses

One of the most fundamental things to understand about trusts is that losses are “trapped” in the trust. This means that the trust cannot distribute the loss to a beneficiary to use at a personal level. This is an important issue for businesses operated through discretionary or unit trusts.

Establishment procedures

The following procedures apply to a trust established by settlement (the most common form of trust):

  • Decide on Appointors and back-up Appointors as they are the ultimate controllers of the trust. They appoint and change Trustees.
  • Settlor determined to establish a trust (should never be anyone who could become a beneficiary)
  • Select the trustee. If the trustee is a company, form the company.
  • Settlor makes a gift of money or other property to the trustee and executes the trust deed. (Pin $10 to the front of the register is the most common way of doing this)
  • Apply for ABN and TFN to allow you open a trust bank account

Establish books of account and statutory records and comply with relevant stamp duty requirements (Hint: Get your Accountant to do this)

Are you looking for an advisor that will keep you up to date and provide guidance and tips like in this blog? then why now contact me at our Castle Hill or Windsor office in Northwest Sydney to arrange a one on one consultation. Just click the Schedule Now button up on the left to find the appointment options.

Liam Shorte B.Bus SSA™ AFP

Financial Planner & SMSF Specialist Advisor™

SMSF Specialist Adviser 

 Follow SMSFCoach on Twitter Liam Shorte on Linkedin NextGen Wealth on Facebook   

Verante Financial Planning

Tel: 02 98941844, Mobile: 0413 936 299

PO Box 6002 BHBC, Baulkham Hills NSW 2153

5/15 Terminus St. Castle Hill NSW 2154

Corporate Authorised Representative of Magnitude Group Pty Ltd ABN 54 086 266 202, AFSL 221557

This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. This website provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

Retirement Planning Tips for 2017 onwards


ID-100407988

Retirement planning is vitally important and with the new rules it may be more important to start as early as possible. New limitations on contributions to super will mean you must be actively making additional contributions sooner. Then when you have been working hard to get money into the super environment, and have complied with all the rules and contribution caps, you want to ensure you are maximising your opportunities when you start to draw on your super savings for a retirement income stream.

What are the changes?

  • A maximum limit of $1.6 million is permitted to be transferred into retirement income stream products.
  • Excessive balances can remain in super in accumulation phase
  • Earnings on assets supporting transition to retirement income streams will be taxed within super

Limits on amounts that can be transferred into retirement income streams

There has been considerable talk in recent times about whether a limit should be placed on the amount that can be accumulated within super and afforded tax concessions. Rather than simply place an arbitrary ceiling on how much can be held inside super, the Government has instead targeted potentially excessive superannuation balances by limiting the amount that will be eligible for the nil tax on earnings concession. From 1 July 2017, the maximum amount that can be placed into retirement income streams will be $1.6 million. For anyone who has started income streams and account balances exceeding that limit, there will be a requirement to roll-back (or withdraw) amounts to bring them in line with these new maximums. The current tax free status of earnings on assets supporting superannuation income streams will only be available to the extent that the income streams are within this new limit.

Excessive balances can remain in superannuation

There is a lot of media hype and some misconceptions floating around at present. It’s important you understand that if you are in the fortunate position to have more than $1.6 million in super, you aren’t forced to withdraw the additional benefits. Amounts above the $1.6 million threshold can remain in super, but must remain in the accumulation phase. Earnings will be taxed at the standard superannuation tax rate of 15% which for many people will be better than paying their marginal tax rate on the earnings if they take the funds out of the system.

Also remember if you have $1.6m in pension then if you take the excess funds out of your SMSF then you will not have an opportunity to put the funds back in as you will be blocked form making further non-concessional (after tax) contributions.

For some, it may be worthwhile to explore taking some of the excess out in to your own names after July 2017 if you have a low level of assets outside in your personal names or through family trusts. But remember if you’re minimum pensions from  the remaining money in superannuation pensions is more than you need to live on then these funds can build up quickly outside of the system and you could be come taxable now or when the first spouse passes.

Earnings on assets supporting transition to retirement income streams will be taxed within super

Despite considerable speculation, the Government has not removed the ability to commence and run transition to retirement (TTR) income streams. TTR income streams are available to you once you reach your preservation age. They allow you to access your super in the form of an income stream without the need to retire or alter your employment arrangements. However, the Government has opted to reduce the concessions available for these income streams. From 1 July 2017, instead of earnings on assets supporting these income streams being exempt from tax within the super environment (as would apply to all other income streams within the new $1.6 million threshold), earnings will instead remain subject to the standard 15% tax rate that applies to funds in accumulation phase.

So for those accessing their super via a TTR so they can salary sacrifice more of their wages back to super within the new $25,000 limit from 1 July 2017, then this is still a very valid strategy. How ever if you have the savings and can manage without accessing your super balance then it may be better to move your fund to accumulation phase.

Look for opportunities to change from a transition to retirement income streams to a full account based pension

If you retire before 60 or leave any one employer after age 60 then you can switch your TTR to a full tax free pension. So think about your situation and do you or can you do marking of exams, AEC electoral role work, stocktaking, Christmas short term employment, part-time survey work, bar work, filling in for family in a business while they go on holidays. If you can document a work arrangement and it genuinely ceases then you can meet that further condition of release which could move your fund in to tax free earnings phase again.

Summary

What hasn’t changed is the tax treatment of superannuation benefits received by individuals from their retirement savings. Payments received after reaching age 60 will continue to be received tax free. To ensure you get the right advice for your situation give us a call on 02 9984 1844 or click here to schedule an appointment

We have offices in Castle Hill and Windsor but can meet clients anywhere in Sydney or via Skype.

Liam Shorte B.Bus SSA™ AFP

Financial Planner & SMSF Specialist Advisor™

SMSF Specialist Adviser 

 Follow SMSFCoach on Twitter Liam Shorte on Linkedin NextGen Wealth on Facebook   

Verante Financial Planning

Tel: 02 98941844, Mobile: 0413 936 299

PO Box 6002 BHBC, Baulkham Hills NSW 2153

5/15 Terminus St. Castle Hill NSW 2154

Corporate Authorised Representative of Magnitude Group Pty Ltd ABN 54 086 266 202, AFSL 221557

This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. This website provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

 

Image courtesy of Stuart Miles at FreeDigitalPhotos.net

Services I Provide as a Professional Financial Planner and SMSF Specialist Advisor


Finding a Professional Adviser

I recently had my 16-year-old son do some work experience in the office and after a few days he asked “what do you do for your clients dad?” I rattled off my elevator speech about my core belief that “I put people back in control of their finances and empower them to plan for a brighter future.” He looked at me as if I had two heads and said “yeah but what do you actually do?” Well that hit me like a brick and I realised that many people do not know what I actually do as a Professional Financial Planner. No not just a Financial Planner but a professional who lives and breathes his work and is building a business around the clients he takes care of and not around the amount of funds under management.

When I sat down with my business partner, Michael Rambaldini, and our team and we looked at what we have done for clients over the last few decades. We split the role in to 5 parts:

  • The financial plan designer who deals with the big picture of your goals and dreams and strategies to achieve them from a financial perspective. As part of this we help get back control by ensuring you are more organised.
  • The relationship builder – someone who earns your trust, becomes your financial coach and guides you through your financial journey with confidence. We deal with many clients so understand the changes in lifestyle and monetary needs as you age.
  • The investment strategist who chooses how to build wealth to fund those objectives. We bring that third-party view to help you avoid emotionally driven investment.
  • The insurance adviser who makes sense of the options available and make an assessment of the needs of the family in terms of risk management and protecting the family’s financial future.
  • The tax consultant (often with an accountant) to minimise the leakage from those returns and ensure compliance.

Now to actually show how that is done and the actual services provided I have made some lists and while not exhaustive they encompass 99% of what I can do for my clients.

A Professional Financial Planner:

  1. Guides you to think about areas of your financial life you may not have considered.
  2. Formalises your goals and puts them in writing.
  3. Helps you prioritise your financial objectives in the right order not what’s easy first.
  4. Helps you determine realistic benchmarks.
  5. Makes you accountable for your own strategies through regular reviews.
  6. Studies possible alternatives that could meet your goals.
  7. Helps you work out your best Salary Sacrifice strategy
  8. Prepares a “big picture” financial plan called a Statement of Advice for you. This should be a reference document for the detailed strategy.
  9. Suggests creative alternatives that you may not have considered including the best way to maximise Centrelink benefits.
  10. Assists you in setting up a Superannuation plan and maybe even an SMSF when the time is right.
  11. Reviews your children’s educational cost funding strategy.
  12. Provides reminders about updates to key financial planning data.
  13. Checks with you before the end of the year to identify any last-minute financial planning needs.
  14. Guides you on ways to fund health care and other lump sum expenses in retirement.
  15. Assists in preparing an estate plan for you.
  16. Cares more about you and your money than anyone who doesn’t share your last name.

A PERSONAL FINANCIAL COACH:

  1. Monitors changes in your life, career and family situation.
  2. Proactively keeps in touch with you with news and ideas, educating you along the way.
  3. Serves as a human glossary of financial terms such as alpha, P/E ratio, and franking credits.
  4. Provides referrals to other professionals, such as accountants, auditors and lawyers.
  5. Shares the experience of dozens of his clients who have also faced circumstances similar to yours. (I’m Irish so I love a story to relay a solution)
  6. Helps with the continuity of your family’s financial plan through generations.
  7. Keeps you on track with reviews to achieve your objectives.
  8. Identifies your savings shortfalls and strategies to plug the gap.
  9. Develops and monitors a strategy for debt reduction.
  10. Is a wise sounding board for ideas you are considering.
  11. I provide the necessary resources to facilitate your decisions, and explaining the opportunities and risks associated with each option.
  12. Provides “the sleep factor” so you are not stressed about money
  13. Is there for your spouse and family should anything happen to you.
  14. Is honest with you, always, even when it means saying NO!

AN INVESTMENT STRATEGIST:

  1. Prepares an asset allocation for you so you can achieve the best rate of return for a given level of risk tolerance.
  2. Stays up to date on changes in the investment world.
  3. Monitors your investments.
  4. Reviews your investments in your company superannuation plans.
  5. Reviews the costs of your existing plan to ensure it is value for money
  6. Helps transition your investments from Accumulation phase to providing a retirement income.
  7. Refers you to mortgage broker for loan and debt financing.
  8. Suggests alternative strategies to increase your income during retirement.
  9. Researches and keeps records of your cost basis on shares and property
  10. Provides you with reliable investment research and often differing views from a range of sources.
  11. Provides you with personal investment analysis.
  12. Determines the risk level of your existing portfolio.
  13. Helps you consolidate and simplify your superannuation and investments.
  14. Can provide you with technical, fundamental, and quantitative investment analysis.
  15. Provides introductions to new investment opportunities.
  16. Shows you how to access your statements and other information online.

AN INSURANCE ADVISER:

  1. Reviews and recommends life, TPD, Trauma and Income Protection insurance policies to protect your family.
  2. Advises on the best structure in terms of within or outside of superannuation to hold the policies
  3. Advises on which entity should own these policies to achieve the desired outcome in the event of a claim.
  4. Looks at Keyman and Business Expenses Insurance for professional and small business clients.
  5. Holding your hand or if the worst happens, your family’s hand while we process a claim with you in the event of illness, injury or death.

A TAX CONSULTANT (within the limits of my licence):

  1. Suggests alternatives to manage income streams and  lower your taxes during retirement.
  2. Reviews your tax strategies/returns with an eye to possible savings in the future.
  3. Stays up to-date on tax law changes.
  4. Helps you reduce your current taxes.
  5. Helps you determine and fund your desired income in retirement and minimum pension payments.
  6. Re-positions investments to take full advantage of tax law provisions.
  7. Facilitates the transfer of investments from individual names to trust(s), or from an owner through to beneficiaries.
  8. Works with your  accountant, tax agent and legal advisers to help you meet your financial goals.

I can’t live your life for you but I can smooth the way!

Are you looking to build that sort of relationship? Do you want a professional advisor that will take the time to build that trusted relationship with you. Please contact me if you want to look at your own options. We have offices in Castle Hill and Windsor but can meet clients anywhere in Sydney or via Skype. Just click the Schedule Now button up on the left to find the appointment options.

Liam Shorte B.Bus SSA™ AFP

Financial Planner & SMSF Specialist Advisor™

SMSF Specialist Adviser 

 Follow SMSFCoach on Twitter Liam Shorte on Linkedin NextGen Wealth on Facebook   

Verante Financial Planning

Tel: 02 98941844, Mobile: 0413 936 299

PO Box 6002 BHBC, Baulkham Hills NSW 2153

5/15 Terminus St. Castle Hill NSW 2154

Corporate Authorised Representative of Magnitude Group Pty Ltd ABN 54 086 266 202, AFSL 221557

This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. This website provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

 

So How Much Can I Contribute to my SMSF Using the Bring Forward Rule


3 Year Bring Forward Rule

3 Year Bring Forward Rule

So the government have announced the revised changes to the budget as outlined in my earlier blog Opportunities after Government back-flip on the superannuation reforms announced in the 2016 Budget. Now to explore in more detail the actual workings of the new Non-Concessional contributions rules and the “Bring Forward Rule” which allows larger lump sums to be contributed by bringing forward 2 future years of the non-concessional contribution cap to the current year.

For 2016-17 the single year capped contribution amount is $180,000 and then from 1 July 2017 it reduces to $100,000. So this year you can still use the bring forward rule to contribute the full $540,000 before June 30th 2017 and that has been confirmed by treasury. However if you do not have enough to meet that full contribution limit you can still trigger your cap by contributing at least $180,001 before the end of the year. Note that you may also have already triggered that rule in one of the 2 previous financials years and be wondering how much of the cap you have remaining. Well this table will clarify that for you.

bring-forward-caps

 

In summary the Limit to Bring Forward Contributions  based on year triggered are:

bring-forward-caps-summary

So for example;

If an SMSF member triggered the Non Concessional Cap bring forward rule this financial year with a $300,000 non-concessional contribution and could not make another NCC contribution before 30 June 2017, they could only contribute $80,000 as a non-concessional contribution in the 2017/18 financial year.

$1.6 million eligibility threshold and how it affects the 3 bring forward rule for contributions made after 1 July 2017

From 1 July 2017 another rule also applies that affects NCC contributions. Individuals are unable to make further NCCs where their total superannuation balance is $1.6 million or more (tested at 30 June of previous financial year). Where an individual’s balance is close to $1.6 million, they can only make a contribution or use the bring forward to take their balance to $1.6 million but not beyond.

Superannuation Balance Contribution and bring forward available
Less than $1,300,000 3 years $300,000
$1,300,000 – $1,400.000 3 years $300,000
$1,400,000 – $1,500.000 2 years $200,000
$1,500,000 – $1,600.000 1 years $100,000
$1,600,000+ NIL

What should you do now

If you are considering making a contribution this year then I strongly recommend that you track your previous 2 years contributions using the above tables  to assess how much you have contributed and how much you can now still contribute under the new rules.

I hope this guidance has been helpful and please take the time to comment. Feedback always appreciated. Please reblog, retweet, like on Facebook etc to make sure we get the news out there. As always please contact me if you want to look at your own options. We have offices in Castle Hill and Windsor but can meet clients anywhere in Sydney or via Skype. Just click the Schedule Now button up on the left to find the appointment options.

Liam Shorte B.Bus SSA™ AFP

Financial Planner & SMSF Specialist Advisor™

SMSF Specialist Adviser 

 Follow SMSFCoach on Twitter Liam Shorte on Linkedin NextGen Wealth on Facebook   

Verante Financial Planning

Tel: 02 98941844, Mobile: 0413 936 299

PO Box 6002 BHBC, Baulkham Hills NSW 2153

5/15 Terminus St. Castle Hill NSW 2154

Corporate Authorised Representative of Magnitude Group Pty Ltd ABN 54 086 266 202, AFSL 221557

This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. This website provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

 

#SMSF Alert : ATO guidance on related party SMSF loans (LRBAs) – Update


ATO guideline LRBAs

The ATO have issued long-awaited guidelines providing SMSF trustees with suggested ‘Safe Harbour’ loan terms on which trustees may use to structure a related party Limited Recourse Borrowing Arrangement (LRBA) consistent with dealing at arm’s length with that related party.

By implementing these “Safe Harbour” loan terms, SMSF trustees are assured by the ATO Commissioner that

..for income tax purposes, the Commissioner accepts that an LRBA structured in accordance with this Guideline is consistent with an arm’s length dealing and that the NALI provisions do not apply purely because of the terms of the borrowing arrangement.

It is absolutely essential that all non-bank SMSF borrowing arrangements (LRBAs)  be reviewed prior now extended to 1 Jan 2017

 Where has this come from?

The ATO first released and then re-issued ATO Interpretative Decisions in 2015 (ATO ID 2015/27 and ATO ID 2015/28), dealing with Non-Arm’s Length Income(NALI) derived from listed shares and real property purchased by an SMSF under an LRBA involving a related party lender – where the terms of the loan were not deemed to be on commercial terms.

These ATOIDs state that the use of a non-arm’s length LRBA gives rise to NALI in the SMSF. Broadly, the rationale for this view is that the income derived from an investment that was purchased using a related party LRBA, where the terms of the loan are more favorable to the SMSF, is more than the income the fund would have derived if it had otherwise being dealing on an arm’s length basis.

NALI is taxed at the top marginal tax rate, currently 47% – regardless of whether the income is derived while the fund is in accumulation phase where tax is normally 15%  or in pension phase when the income would usually be tax exempt.

After that bombshell, the ATO announced that it would not take proactive compliance action from a NALI perspective against an SMSF trustee where an existing non-commercial related party LRBA was already in place, as long as such an LRBA was brought onto commercial terms or wound up by 30 June 2016.

The Nitty Gritty Details of the Safe Harbour Steps

The ATO has issued Practical Compliance Guideline PCG 2016/5. As a result, provided an SMSF trustee follows these guidelines in good faith, they can be assured that (for income tax compliance purposes) their arrangement will be taken to be consistent with an arm’s length dealing.

The ‘Safe Harbour’ provisions are for any non-bank LRBA entered into before 30 June 2016, and also those that will be entered into after 30 June 2016.

Broadly, this PCG outlines two ‘Safe Harbours’. These Safe Harbours provide the terms on which SMSF trustees may structure their LRBAs. An LRBA structured in accordance with the relevant Safe Harbour will be deemed to be consistent with an arm’s length dealing and the NALI provisions will not apply due merely to of the terms of the borrowing arrangement.

The terms of the borrowing under the LRBA must be established and maintained throughout the duration of the LRBA in accordance with the guidelines provided.

Safe Harbour 1 Safe Harbour 2
Asset Type Investment in Real Property Investment in a collection of Listed Shares or Units
Interest Rate RBA Indicator Lending Rates for banks providing standard variable housing loans for investors. Use the May rate immediately preceding the tax year.
(2015-16 year = 5.75%)(2016-17 year = 5.65%)

(2017-18 year = 5.8%)

Same as Real Property + a margin of 2%
Fixed / Variable Interest rate may be fixed or variable. Interest rate may be fixed or variable.
Term of Loan Variable interest rate loans:

Original loan – 15 year maximum loan term (both residential and commercial).

 

Re-financing – maximum loan term is 15 years less the duration(s) of any previous loan(s) in respect of the asset (for both residential and commercial).

 

Fixed interest rate loan:

Rate may be fixed for a maximum period of 5 years and must convert to a variable interest rate loan at the end of the nominated period. The total loan term cannot exceed 15 years.

 

For an LRBA in existence on publication of these guidelines, the trustees may adopt the rate of 5.75% as their fixed rate provided that the total period for which the interest rate is fixed does not exceed 5 years. The interest rate must convert to a variable interest rate loan at the end of the nominated period. The total loan term cannot exceed 15 years.

Variable interest rate loans:

Original loan – 7 year maximum loan term.

 

Re-financing – maximum loan term is 7 years less the duration(s) of any previous loan(s) in respect of the collection of assets.

 

Fixed interest rate loan:

Rate may be fixed up to for a maximum period of 3 years and must convert to a variable interest rate loan at the end of the nominated period. The total loan term cannot exceed 7 years.

 

For an LRBA in existence on publication of these guidelines, the trustees may adopt the rate of 7.75% as their fixed rate provided that the total period for which the interest rate is fixed does not exceed 3 years. The interest rate must convert to a variable interest rate loan at the end of the nominated period. The total loan cannot exceed 7 years.

Loan-Value –Ratio

LVR

Maximum 70% LVR for both commercial & residential property.
Total LVR of 70% if more than one loan.
Maximum 50% LVR.

Total LVR of 50% if more than one loan.

Security A registered mortgage over the property. A registered charge/mortgage or similar security (that provides security for loans for such assets).
Personal Guarantee Not required Not required
Nature & frequency of repayments Each repayment is to be both principal and interest.

Repayments to be made monthly.

Each repayment is to be both principal and interest.

Repayments to be made monthly.

Loan Agreement A written and executed loan agreement is required. A written and executed loan agreement is required.
Information sourced from Practical Compliance Guidelines PCG 2016/5.

Potential Trap to be aware of: Importantly, as part of this announcement, the ATO also indicated that the amount of principal and interest payments actually made with respect to a borrowing under an LRBA for the year ended 30 June 2016 must be in accordance with terms that are consistent with an arm’s length dealing.Information sourced from Practical Compliance Guidelines PCG 2016/5.

Where to find the Indicator Rate in future year:

The PGS referred to: Reserve Bank of Australia Indicator Lending Rates for banks providing standard variable housing loans for investors. Applicable rates:
– For the 2015-16 year, the rate is 5.75%
– For the 2016-17 year the rate is 5.65%

For 2017-18 and later years, the rate published for May (the rate for the month of May immediately prior to the start of the relevant financial year)

It is the applicable rate under Column N of the above spreadsheet (click on link). The rate seems to have started in August 2015 but I assume we must use the May rate from now on.

In referencing the Indicator Rate you can use:
Ref: Title: Lending rates; Housing loans; Banks; Variable; Standard; Investor
Lending rates; Housing loans; Banks; Variable; Standard; Investor
Frequency: Monthly
Units: Per cent per annum
Source RBA
Publication Date 04-Apr-2016
Series ID: FILRHLBVSI

Example – Real Property taken from Practical Compliance Guideline PCG 2016/5 Example 1

A complying SMSF borrowed money under an LRBA, using the funds to acquire commercial property valued at $500,000 on 1 July 2011.

  1. The borrower is the SMSF trustee.
  2. The lender is an SMSF member’s father (a related party).
  3. A holding trust has been established, and the holding trust trustee is the legal owner of the property until the borrowing is repaid.

The loan has the following features:

  1. the total amount borrowed is $500,000
  2. the SMSF met all the costs associated with purchasing the property from existing fund assets.
  3. the loan is interest free
  4. the principal is repayable at the end of the term of the loan, but may be repaid earlier if the SMSF chooses to do so
  5. the term of the loan is 25 years
  6. the lender’s recourse against the SMSF is limited to the rights relating to the property held in the holding trust, and
  7. the loan agreement is in writing.

Consistent with ATO ID 2015/27 and ATO ID 2015/28, the LRBA is not considered to have been established or maintained on arm’s length terms. The income earned from the property, which is rented to an unrelated party, will give rise to NALI.

At 1 July 2015, the property was valued at $643,000, and the SMSF has not repaid any of the principal since the loan commenced.

To avoid having to report NALI for the 2015-16 year (and prior years) the Fund has a number of options.

Option 1 – Alter the terms of the loan to meet guidelines

The SMSF and the lender could alter the terms of the loan arrangement to meet Safe Harbour 1 (for real property).

To bring the terms of the loan into line with this Safe Harbour, the trustees of the SMSF must ensure that:

  1. The 70% LVR is met (in this case, the value of the property at 1 July 2015 may be used).

Based on a property valuation of $643,000 at 1 July 2015, the maximum the SMSF can borrow is $450,100. The SMSF needs to repay $49,900 of principal as soon as practical before 30 June 2016.

  1. The loan term cannot exceed 11 years from 1 July 2015.

The SMSF must recognise that the loan commenced 4 years earlier. An additional 11 years would not exceed the maximum 15 year term.

  1. The SMSF can use a variable interest rate. Alternatively, it can alter the terms of the loan to use a fixed rate of interest for a period that ensures the total period for which the rate of interest is fixed does not exceed 5 years. The loan must convert to a variable interest rate loan at the end of the nominated period.

The interest rate of 5.75% applies for 2015-16 and 5.65% p.a. applies from 1 July 2016 to 30 June 2017. The SMSF trustee must determine and pay the appropriate amount of principal and interest payable for the year. This calculation must take the opening balance of $500,000, the remaining term of 11 years, and the timing of the $49,900 capital repayment, into account.

  1. After 1 July 2016, the new LRBA must continue under terms complying with the ATO’s guidelines relating to real property at all times.

For example, the SMSF must ensure that it updates the interest rate used for the loan on 1 July each year (if variable) or as appropriate (if fixed), and make monthly principal and interest repayments accordingly.

Option 2 – Refinance through a commercial lender

The fund could refinance the LRBA with a commercial lender, extinguish the original arrangement and pay the associated costs.

While the original loan remains in place during the 2015-16 income year, the SMSF must ensure that the terms of the loan are consistent with an arm’s length dealing, and relevant amounts of principal and interest are paid to the original lender.

The SMSF may choose to apply the terms set out under Safe Harbour 1 to calculate the amounts of principal and interest to be paid to the original lender for the relevant part of the 2015-16 year.

Option 3 – Payout the LRBA

The SMSF may decide to repay the loan to the related party, and bring the LRBA to an end before 30 June 2016.

While the original loan remains in place during the 2015-16 income year, the SMSF must ensure that the terms of the loan are consistent with an arm’s length dealing, and the relevant amounts of principal and interest are paid to the original lender.

The SMSF may choose to apply the terms set out under Safe Harbour 1 to calculate the amounts of principal and interest to be paid to the original lender for the relevant part of the 2015-16 year.

Each option will have many advantages and disadvantages – so it is important to understand what the practical implications of each option are, and how physically you will approach each option. Seek specialised advice on this matter as it is not a strategy suitable for DIY implementation

Important Note to 13.22C or Unrelated Unit Trust Investors

The guidelines provided in this PCG are not applicable to an SMSF LRBA involving an investment in an unlisted company or unit trust (e.g. where a related party LRBA has been entered into to acquire a collection of units in an unrelated private trust or a 13.22C compliant trust). As such, trustees who have entered into such an arrangement will have no option but to benchmark their particular loan arrangement based on commercial loan terms, or to bring the LRBA to an end.

Please visit out SMSF Property page to get details on all available strategies for SMSF property investors.

UPDATE (Relief for those caught by Budget measures)

In a letter to an industry association, the Treasurer, Scott Morrison, has outlined transitional arrangements to allow additional non-concessional contributions above the proposed lifetime limit in certain limited circumstances. Contributions made in the following circumstances may be permitted without causing a breach of the lifetime cap:

  • where the trustees of a self managed superannuation fund (SMSF) have entered into a contract to purchase an asset prior to 3 May 2016 that completes after this date and non-concessional contributions were planned to be made to complete the contract of sale. Non-concessional contributions will be permitted only to allow the contract to complete provided they are within the relevant non-concessional cap that was applicable prior to Budget night, and
  • where additional contributions are made in order to comply with the Australian Taxation Office’s (ATO) Practical Compliance Guideline (PCG) 2016/5 related to limited recourse borrowing arrangements, provided they are made prior to 31 January 2017.

Additional non-concessional contributions made under these proposed transitional arrangements will count towards the lifetime cap, but will not result in an excess.

I hope this guidance has been helpful and please take the time to comment. Feedback always appreciated. Please reblog, retweet, like on Facebook etc to make sure we get the news out there. As always please contact me if you want to look at your own options. We have offices in Castle Hill and Windsor but can meet clients anywhere in Sydney or via Skype. Click here for appointment options.

Liam Shorte B.Bus SSA™ AFP

Financial Planner & SMSF Specialist Advisor™

SMSF Specialist Adviser 

 Follow SMSFCoach on Twitter Liam Shorte on Linkedin NextGen Wealth on Facebook   

Verante Financial Planning

Tel: 02 98941844, Mobile: 0413 936 299

PO Box 6002 BHBC, Baulkham Hills NSW 2153

5/15 Terminus St. Castle Hill NSW 2154

Corporate Authorised Representative of Magnitude Group Pty Ltd ABN 54 086 266 202, AFSL 221557

This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. This website provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

%d bloggers like this: