The Cooper Review is the product of the Federal Government commissioning for a sweeping review to examine the governance, operation, efficiency and structure of Australia’s superannuation system and was released in June 2010. The Government will now consider the report over the coming months and will provide its own response to the recommendations made in due course. This response will include information regarding which recommendations it will seek to adopt and those that will be discarded, along with reasons for such decisions.
The report recognises that the Self-Managed Super Fund (SMSF) sector in Australia has a number of different and unique characteristics, and has identified 10 guiding principles that should broadly underpin the regulation of SMSFs.
Freedom from intervention
Freedom from intervention but not complete absence of intervention
Appropriate entry into SMSFs
Consistent treatment with large APRA funds where appropriate
Recognition of special risks in an SMSF environment
Compliance, rather than prudential, regulatory focus
Pursuit of excellence
The vision and intention for SMSFs is that superannuation savings should be invested for the sole purpose of providing retirement savings. However, there exists substantial opportunity for SMSF members to engage in behaviour that is inconsistent with government policy and the purpose of their fund through related party investment. Often this can eventuate as a result of the investment focus shifting, either consciously or subconsciously, from a long term investment and retirement strategy, to one of short term gain. The regulation of this type of unaccepted behaviour was perhaps the primary concern for SMSF members with property investment as they anticipated the release of the Cooper Review findings.
Cooper Review recommendations
In 2007, the Superannuation Industry Supervision (SIS) Act 1993 (which was designed and enacted to ensure the prudent management of superannuation funds; providing a framework for making investment decisions, administration guidelines, record keeping and the processing of member benefits) was amended to allow SMSFs, as with all regulated superannuation funds, to invest in instalment warrants.
Instalment warrants are a form of financial product that entail borrowing to invest in an asset (such as property or shares), with limited risk to the investor. These changes were then given extra safeguards this year, when the Government introduced consumer protection framework and further legislation clarifying the limited recourse nature of instalment warrants.
Though there was some initial concern that the Cooper Review would suggest increased regulation in this area, the Panel has indicated that it recognises that these previous changes are still relatively recent. Consequently, the recommendation put forth regarding investment warrants is as follows:
Recommendation 8.10 The 2007 relaxation of the borrowing provisions and the consumer protection measures that have recently been announced should be reviewed by the government in two years’ time to ensure that borrowing has not become, and does not look like becoming, a significant focus of superannuation funds.
So for the time being, the Panel is allowing those who are currently engaged in instalment warrants to continue in these activities, while recognising that this may be a concern in the future. It was only in May this year (2010) that the Government introduced a further SIS Amendment, clarifying the borrowing rules. Some of the matters that have been clarified by the Australian Tax Office following the changes include:
SMSFs are permitted to borrow for the purpose of making capital improvements to a property acquired under the borrowing arrangement.
Funds are permitted to acquire multiple assets, such as a number of properties under the same arrangement.
Refinancing of loans are permitted, when the new borrowing is being arranged to replace a previous borrowing, and address the costs of placing the asset into a new arrangement.
Borrowed money is not permitted to be used to build a house on vacant land already owned by the fund.
The Cooper Review has also made some recommendations about In-House Assets (IHA) that could impact in a different way on SMSF members who hold property (other than business property):
Recommendation 8.12 SIS legislation, in relation to SMSFs, should be amended so that:
The 5% IHA investment limit be removed so that no IHA investments would be allowed;
SMSFs with existing IHA investments be provided a five year transition period, in which to convert to a Small APRA Fund (SAF) or, alternatively, dispose of their IHA investments. No acquisitions of IHA investments would be permissible during the transition period; and
APRA-regulated funds be exempt from these changes.
Breaking this recommendation down part-by-part, it’s essential to define the terminology:
IHA: In-house Asset. These are assets of the fund that are loans to or investments in a related party of the fund, or an investment in a related trust, or an asset of the fund that is subject to a lease between the trust and a related party. Generally, a related party is a member of the fund, an employer that contributes to the fund or an associate of the fund.
SAF: A Small APRA Fund is a fund with fewer than 5 members with a trustee approved by APRA, who has at least $5 million in net assets and has the sufficient skills and competence to act as trustee.
This recommendation is suggesting that all SMSFs be required to dispose of their existing IHA investments, or convert to a SAF fund. The Cooper Review has recommended a five-year period for this transition, during which no further IHA investments are permissible. This means that SMSFs will have to focus on more conventional assets such as listed shares or bonds. It’s important to note, however, that this recommendation excludes business real property, as the Panel recognises that this type of investment provides a valuable opportunity for small business owners to provide for their retirement. SMSFs will need to ensure that any related-party acquisitions and disposals comply with new requirements for valuation (that is the suggestion that all investment transactions be conducted at market value), if these recommendations are implemented by the Government.
Another recommendation that carries weight for property investors is the following:
Recommendation 8.28 Legislation should be passed so that the covenant requiring separation of fund assets from personal or employer assets, as set out in section 52(2)(d) of SIS, be replicated in a SIS operating standard.
This recommendation suggests that the current covenant become legislation, requiring trustees to keep the books and accounts of the fund separate from those of other members or entities. This transparency is important to maintain the security of the assets, and thereby potentially lessens the risk of losing the assets to other parties.
It’s important to remember that the abovementioned are simply an overview of some of the recommendations put forward by the Cooper Review. The Federal Government has not yet given any indication regarding their response; although the current Financial Services Minister, Chris Bowen, has said that the formal response will be made over the next two months. While nothing has been adopted by the Government as yet, if you are concerned about how these recommendations may affect your current Self-Managed Super Fund arrangements or your investment property, it is important that you seek independent professional advice.
Michael Quinn, Director of The Quinn Group, is an experienced lawyer, accountant and educator. If you would like further information or assistance, Michael and the team of legal and accounting professionals at The Quinn Group can be contacted by calling 1300 QUINNS (784 667) or visiting the website www.quinns.com.au and submitting an online enquiry.