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Superannuation Legislation Amendment Bill (No. 4) 1999
(a) Fund numbers are preliminary estimates only
based on 1997-98 trends.
Bills Digest No. 44 1999-2000
This Digest was prepared for debate. It reflects the legislation as introduced and does not canvass subsequent amendments. This Digest does not have any offici al legal status. Other sources should be consulted to determine the subsequent official status of the Bill.
Superannuation Legislation Amendme nt Bill (No. 4) 1999
To tighten the investment rules a pplicable to regulated superannuation funds by extending the restrictions on acquiring assets to related parties of the fund, i.e. relatives of fund members, and related companies, individuals, trusts and other entities. The amendments also expand the classes of assets exempt from the restrictions on the acquisition of in-house assets.
The changes made by this Bill include:
- Amending the coverage of the in-house asset rules so that they include investments in, loans to, and leases and lease arrangements with, a related party of the fund. In-house investments will also include investments in a related trust.
- Providing a definition of a related party of a superannuation fund, which includes a member of a fund, an associate of a member of a fund, a standard employer-sponsor of a fund, and an associate of a standard employer-sponsor of a fund.
- Strengthening the provision that applies where an investment is not an in-house asset, but has the effect of achieving an investment in an in-house asset.
- Providing that the in-house asset rules do not cover business real property leased by a superannuation fund with less than 5 members or investments in widely held unit trusts.
- Allowing superannuation funds with fewer than 5 members to use up to 100 per cent of their assets to purchase business real property.
- Providing transitional arrangements for the changes to the in-house asset provisions.
The rapid growth of superannuation over the past two decades has a number of causes, such as: changes to Federal industrial awards to provide for employer contributions; the widening of occupational superannuation through the introduction of the superannuation guarantee scheme; and a growing awareness, both within the public and government, that a desired lifestyle in retirement will generally not be available solely on an aged pension and that taxpayers will find it increasingly difficult to finance the aged pension, particularly through the years when the 'baby boomer' generation reaches retirement age.
The attractiveness of superannuation as a savings vehicle for retirement is principally the concessional taxation treatment of complying superannuation funds and retirement savings accounts (RSAs), which are subject to a 15 per cent tax rate on member cont ributions and earnings. While superannuation coverage is very high for employees (91 per cent) and all workers (81 per cent), largely due to the compulsory superannuation guarantee scheme, coverage is substantially less for employers (36 per cent).(1) This may be due to employers having other preferred savings vehicles, such as investment in a business.
Superannuation funds may be classified as falling within a number of categories depending largely on to whom they are offe red, who is eligible to be a member of the fund and the number of members of the fund. The differing types of funds may be subject to differing regulatory requirements. The following table gives a list of the number of funds, membership and assets of various categories of funds for March 1999:
Annuities, life office reserves, etc.
(a) Fund numbers are preliminary estimates only
based on 1997-98 trends.
Source: Australian Prudential Regulation Authority, Superannuation Industry at a Glance-March 1999 .
Excluded funds or self managed superannuation funds (SMSFs) have the principal characteristic of being restricted to fewer than 5 members, which explains the relative small number of total members compared to the large number of funds shown above.
Excluded funds, as they are presently known, will be re-named as SMSFs following the passage of the Superannuation Legislation Amendment Bill (No. 3) 1999.
Members, assets and costs
The majority (85 per cent) of excluded funds/SMSFs h ave only one or two members, with 15 per cent having three or four members.(2)
The following table shows how excluded funds/SMSFs enjoy significantly higher average assets per account than do members of other sectors of the superannuation industry.
Averag e assets per account (June 1997)
Average account balance
Source: Australian Prudential Regulation Authority, 'Focus on Excluded Funds', APRA Bulletin June Quarter 1998 , p.7
Excluded funds/SMSFs are typically created with a rollover or inward transfer from another fund. Average assets per account have increased at around 12 per cent per year over the six years from 1992. Over 85 per cent of excluded fund assets are managed directly by the fund. This is dramatically different to the figure of 16 per cent for other superannuation funds. A negligible fraction of excluded funds/SMSFs' assets are invested overseas, compared with 8 per cent of assets for other superannuation funds. The Australian Prudential Regulation Authority's (APRA) research indicates that excluded funds/SMSFs adopt a far more conservative approach to investment than other superannuation funds. In particular, they adopt a considerably greater emphasis on cash and property, and far less involvement with equities and securities.(3)
Conservative investment strategies have not meant low returns for excluded funds/SMSFs. The average return on invested assets for excluded funds in 1995-96 was 13 per cent, and in 1996-97 was 11 per cent. The generally higher returns achieved by excluded funds/SMSFs compared to other superannuation funds are, in part, driven by relatively lower administration costs.(4)
Excluded funds/SMSFs do not have to comply with all of the regulatory requirements imposed by the Superannuation Industry (Supervision) Act 1993 (SIS Act) and regulations to receive their complying status and hence concessional taxation. Examples of differences between excluded funds/SMSFs and other regulated funds are that the trustee/s of an excluded fund do not need APRA's approval, the acquisition of property from members is more relaxed for excluded funds/SMSFs, information and reporting requirements are less for excluded funds/SMSFs and other investment rules are less restricted than for other funds. The lower prudential requirements reflect the risk borne with excluded funds/SMSFs, which is based on the restricted number of members having a greater opportunity to possess knowledge of the funds operations. Such funds are also known as D.I.Y. super funds because, as the term implies, the members of the fund can take an active role in the decision making of the fund, although the final decision may rest with the trustee/s.
The appropriateness of lower prudential standards for excluded funds/SMSFs can be questioned when the relationship between the trustee and members of the fund becomes such that there is no ability for the member to affect the trustee so that the member is in much the same situation (except relating to regulatory controls) as a member of a larger fund.
Superannuation in general, and the position of excluded funds/SMSFs, was examined by the Financial System Inquiry, which reported in March 1997 (Wallis Report). The Report considered excluded funds/SMSFs to 'provide a worthwhile and competitive option' but as self-managed funds should not be subject to prudential regulation. It recommended that supervision of excluded funds/SMSFs be transferred to the Australian Taxation Office (ATO) as the body which has the responsibility of determining if the fund is a complying fund or not.(5) The Wallis Report also commented:
At present, some excluded funds have beneficiaries who are at arm's length from the trustees. This is unsatisfactory to the extent that there is little protection of the interests of these third-party beneficiaries and because there is little practical scope for effective prudential regulation of such funds. The Inquiry considers that funds which have third-party beneficiaries should not be regarded as excluded funds. On balance the Committee would prefer to discourage this particular configuration of superannuation structure.
The Committee believes that there is an opportunity to improve the prudence and compliance of excluded funds by requiring all beneficiaries of such funds to be trustees.(6)
Changes to the regulation of excluded funds/SMSFs were announced in the 1998-99 Budget. The main changes relate to:
- introducing a category of self managed funds which will replace excluded funds, with the new name reflecting the investment management of the fund
- a self managing fund will be one with fewer than 5 members (as with excluded funds) where:
- all members are trustees and there are no other trustees of the fund, and
- if there is more than one member of the fund, all fund members are either [business] partners, directors or trustee of the employer-sponsor or family relatives.
- transferring responsibility for the management of self managed funds from APRA to the Australian Taxation Office.
The Government proposes to implement these proposals via Superannuation Legislation Amendment Bill (No. 3) 1999, which was introduced into the House of Representatives on 31 March 1999. Reference is invited to Bills Diges t No. 188 1998-99.
The SIS Act presently contains a number of rules governing investment activities by superannuation funds. Collectively, these rules are designed to limit the risks associated with superan nuation fund investments and to ensure that superannuation savings are preserved until retirement and not accessed for current use. The investment rules in the existing legislation include:
- A superannuation fund is limited to holding no more than a specified percentage of fund assets in the form of 'in-house assets'. An 'in-house asset' is currently defined as a loan to, or an investment in, an employer-sponsor or an associate of an employer-sponsor. The SIS Act reduces the limit to 5 per cent of the market value of fund assets from the end of 2000-01 (the 5 per cent limit already applies to new investments). This rule limits the risk to superannuation savings from investment in an employer-sponsor or associate.
· Superannuation funds are generally not permitted to borrow in their own right. This is designed to reduce the risk to retirement income from funds gearing their assets.
· Superannuation funds are not permitted to acquire assets from members and their relatives, except for listed securities and - for a fund with fewer than 5 members (ie, an excluded fund/SMSF) - up to 40 per cent of assets being used to acquire business real property. This is designed to limit the scope for non-arm's length transactions with related parties that result in early access to superannuation savings for non-retirement purposes.
· Superannuation funds are prohibited from lending or providing other financial assistance to members and relatives. This is to prevent the use of superannuation savings as a means of providing current day financial support to members.
· There is a general requirement that superannuation funds make investments on arm's length terms. Essentially, this means that investments should be entered into, and maintained, on commercial terms. This has the objective of limiting non-arm's length transactions that result in early access to superannuation savings for non-retirement purposes.
In early 1997, the then superannuation regulator, the Insurance and Superannuation Commission (ISC) undertook a random survey of around 1,000 excluded f unds/SMSFs. The survey did not include funds with assets of less than $30,000 nor funds where all assets were in life insurance policies.
Findings of the survey included:
- Around 20 per cent of funds surveyed were investing in unit trusts that were effectively controlled by the fund members or the employer. Around one half of these unit trusts were undertaking geared investments (that is, gearing up money received from the superannuation funds).
- Around 13 per cent of funds surveyed were leasing or renting assets to associated parties (such as members or employers).
More detailed survey fieldwork examined around 100 selected excluded funds/SMSFs. These provided examples of excluded funds/SMSFs funds investing in unit trusts, which in turn invested in the emplo yer-sponsor, made loans to members and employer-sponsors and leased assets to members and employer-sponsors.
The Government argues that the practices identified by the ISC survey and fieldwork affect the integrity of the investment rules.
Superannuation savings are being transferred into related trusts that are not subject to the investment rules or other SIS regulation, and which are controlled by an employer-sponsor or member. Even if permitted by legislation, it would be complex and resource intensive for the regulators to apply the investment rules to superannuation funds on the basis of activities undertaken by an increasing number of unregulated, related entities. The task would become increasingly difficult. By way of illustration, at March 1999 there were around 186,000 superannuation funds, compared with around 100,000 funds in June 1995.
If a superannuation fund invests in a related trust, the employer or member is able to use the assets in a geared investment, which the superannuation fund could not undertake directly. This circumvents the rule that prevents borrowing by a superannuation fund.
Assets are being leased to an employer-sponsor or member, either through a unit trust or directly by a superannuation fund. This results in the fund’s assets being committed to the employer’s business or being accessed for current day use by members.(7)
The Government argues that these practices undermine the effectiveness of the existing investment rules that are designed to reduce the risks of superannuation investments and ensure that superannuation savings are preserved for retirement purposes.
In order to address concerns about the investment practices of excluded funds/SMSFs that became apparent in the ISC survey, the Government announced in the 1998-99 Budget changes to investment rules that will effect excluded funds/SMSFs.(8)
The Government announced that from the date of the introduction of the legislation, all superannuation funds (including excluded funds/SMSFs) would be permitted to hold no more than 5 per cent of the fund's assets (calculated on market value) in certain asset classes. These include:
- investments in associated parties, including trusts
- investments involving associated parties eg., leasing assets to members or employer-sponsors (exceptions will apply to ensure consistency with the rules relating to the acquisition of property used in the business - the 40 per cent rule), and
- investments in certain 'non-associated parties' which invest directly or indirectly in the employer-sponsor or its associates (these restrictions would not apply to certain specified investments such as widely held trusts).
The 1998-99 Budget also announced that current restrictions on acquisitions of assets from members and relatives will be extended to all associates, and that in respect to existing investments, funds will have until 30 June 2001 to comply with the new inve stment rules.
On 28 May 1998, the Assistant Treasurer announced modifications to the transitional arrangements for the proposed new investment rules.(9)
In response to concerns raised by industry that the proposed new i nvestment rules would have a retrospective effect, the Government decided that the new restrictions would not apply to investments made before 7.30pm 12 May 1998 (Budget night), and that such investments remain subject to the existing law.
Transitional arrangements for investments made after 7.30pm on 12 May 1998 continue to apply as announced in the 1998-99 Budget. That is:
- for investments made between Budget night and the introduction of the legislation, funds will have until 30 June 2001 to comply with the new rules; and
- investments made by funds after the introduction of the legislation will be required to comply with the new rules.
The Government also announced that draft legislation implementing the proposed new investment rules would be issued for co nsultation and comment prior to its introduction into Parliament.
On 22 April 1999, the Assistant Treasurer released for public comment and industry consultation, an exposure draft of the Superan nuation Legislation Amendment Bill (No.4) 1999, to give effect to the proposed new superannuation investment rules.(10)
The Government also announced an easing of the investment rules for small superannuation funds directly acquiring business real property from members or their relatives, that small superannuation funds can continue to directly lease business real property to members or an employer-sponsor, and more generous transitional arrangements.
Extended business real property exception for excluded funds/SMSFs
The Government decided to extend the business real property exemption for excluded funds/SMSFs from 40 per cent to 100 per cent. That is, a superannuation fund with fewer than 5 members will be able to invest up to 100 per cent of its assets in business premises that are leased to members or the employer-sponsor of the fund. According to the Government, the extended exemption enhances the ability of small business owners to use their superannuation savings to invest in their own business premises.
The extended exemption recognises that land and buildings generally have an underlying value independent of the employer-sponsor's business. Acquisitions of property and leasing arrangements need to be made on an arm’s length basis and in a manner consistent with the requirements of the SIS Act.
Further transitional arrangements
The Government announced more generous transitional measures to assist superannuation funds that had particular investment arrangements in place before 1998-99 Budget night. The G overnment announced the following changes:
- Grandfathering (ie, permanently exempting from the changes) all investments and loans made before 7.30pm 12 May 1998 (Budget night). The grandfathering for loans continues until the loans are repaid.
- Grandfathering assets that were subject to a lease before 7.30pm 12 May 1998. Grandfathering of a leased asset will continue while the same asset is leased to the same related party (ie effectively a lease on that asset can be rolled over, even if this is not provided for in the original agreement).
- Grandfathering all investments and loans made after 7.30pm 12 May 1998 under legally binding contracts entered into before 7.30pm 12 May 1998.
- Grandfathering assets subject to a lease after 7.30pm 12 May 1998 under a legally binding lease entered into before 7.30pm 12 May 1998 (while the asset continues to be leased to the same party).
- Grandfathering payments on partly paid shares and partly paid units where the shares or units were acquired before 7.30pm 12 May 1998 or acquired under a pre-Budget contract.
- Exempting until 1 July 2001 any investments and loans made after Budget night but prior to the introduction of the legislation, and assets that became subject to a lease during this period
- where the investments, loans or assets were not otherwise covered by the exemption for pre-Budget legally binding contracts or leases.
In addition, a superannuation fund will be able to continue to reinvest earnings from a pre-Budget investment in the same associated entity (including reinvestment of earnings on earning s in the associated entity). This will allow the purchase of additional units in a unit trust, up to the amount of earnings reinvested. The ability of the fund to reinvest earnings in an associated entity will continue until 30 June 2005. Re-investments up to that date would not need to be unwound, that is, they would be excluded from the definition of in-house asset.
On 11 August 1999, the Superannuation Legislation Amendment Bill (No.4) 1999 was introduced into the House of Representatives.
The Government made a number of policy changes to address issues raised during consultation on the exposure draft of the legislation.(11) These changes are as follows:
- Small superannuation funds will be allowed to make additional investments (and loans) into related trusts and companies until the end of 30 June 2009, up to the amount of any debt outstanding at 12 May 1998. This change addresses concerns that some related entities may otherwise have had difficulty in repaying existing debt. A small fund may elect to use this transitional provision as an alternative to previously announced transitional arrangements.
- The previously announced transitional arrangement for reinvestment of earnings will be extended to 30 June 2009 (rather than 30 June 2005).
- The transition period will be extended so that investments and loans made between 12 May 1998 and when the legislation receives Royal Assent will not be treated as in-house assets until 1 July 2001 (if they would not previously have been in-house assets). Assets leased before the date of Royal Assent will also be covered by this transitional provision.
- To provide greater consistency between the transitional arrangements, the provision allowing additional payments on partly paid shares and units will have a cut off date of 30 June 2009.
- The business real property exceptions will be available for real property used wholly and exclusively in one or more business, regardless of who is conducting the business. For instance, this would accommodate the situation where a small superannuation fund leases a business property to a related party who sub-leases part of the property to another business.
The provisions were also been amended to provide greater flexibility for the business real property exceptio ns to be used for farm properties, by ensuring that a property containing a farmhouse can qualify for the exception.
The business real property exceptions allow a small superannuation fund to invest up to 100 per cent of its assets in acquiring business real property from a related party and also allows up to 100 per cent of its assets to be used in business real property leased to a related party.
The main changes to be introduced by the Bill, ie the extension of restriction of a fund from investing in in-house assets or loans will be achieved by the insertion of a wider group of related entities to which the restrictions in investments/loans apply. As a consequence of the restrictions applying to a wider range of entities, further types of investments are excluded from the restrictions, including the removal of the 40 per cent restriction on the investment in business real property of a related entity.
Items 1 to 7 of Schedule 1 of the Bill will amend the SIS Act to insert a number of definitions, including those for:
Entity: an individual, body corporate, partnership and trust.
Lease arrangement: the term is given a wide meaning to include any arrangement, agreement or understanding between a trustee and another under which the other person has the use of, or can control the use of, property owned by the fund. The definition will apply even if the arrangement etc is not enforceable at law.
Related party: a member of the fund, a standard-employer sponsor of the fund (ie an employer who contributes to a fund for the benefit of an employee, their associate or dependants under an agreement between the employer and trustee of the fund), or a Part 8 associate (see below).
Related trust: a trust that a member or employer-sponsor of the superannuation fund controls.
Relative: parent grandparent, sister, brother, uncle, aunt nephew, niece or linear descendant or an adopted child or a spouse of the above.
Section 66 of the SIS Act imposes restrictions on the acquisition of assets by a regulated fund from members of the fund or relatives of a member. Real business property and listed securities are exempt from the investment restrictions. Item 9 will amend section 66 to extend the restrictions to the acquisition of certain assets from related parties. Item 12 will extend the exemption from the restrictions to most in-house assets acquired at market value. (In-house asset is defined in section 71 of the SIS Act to be a loan to or investment in a standard employer-sponsor or an associate of such an entity, with certain exceptions that apply to investments that are normally dealt with at arms' length, such as investments with deposit taking institutions (ADI), life policies with a life insurance company, a deposit with an approved non ADI financial institution, an investment in a pooled superannuation fund or assets of a public sector fund that consists of government and/or public authority securities or assets approved by APRA). The further exemptions contained in item 12 will not apply to a life insurance policy issued by a life insurance company if the policy is acquired from a member of the fund or their relative. The exemptions will also not apply if the acquisition would result in the level of in-house assets exceeding that allowed under Part 8.
Application : The amendments contained in items 9 and 12 will apply from the time the Bill was introduced in Parliament unless the asset was acquired under a contract entered into before 7.30pm on 12 May 1998 (ie the time of the Budget announcement) [ subitem 45(1) ].
The definition of business real property, in which investment is allowed, will be altered and expanded by item 15 to include a wider range of interests in business real property, and land used in primary production will include up to 2 hectares used for domestic or private purposes ( item 22 ). This amendment, combined with the amendment of the current definition, and the definition of an acceptable percentage by item 14 , will remove the current restriction on investment in the business real property of an employer sponsor of 40 per cent.
Item 25 will insert a new Subdivision B into Part 8 of the SIS Act. Proposed section 70B deals with associates of individuals and has a wide definition which includes:
- for excluded funds: members of the fund or directors or trustees of an excluded fund with a single member
- members of a [business]partnership with the individual or the spouse or child of the member/s
- a trustee where the individual controls the trust, and
- a company which is sufficiently influenced by the individual and/or an associate/s or in which those people hold a majority voting interest.
Proposed section 70C deals with associates of companies and has a wide definition that will allow the tracing of interests through interposed entities. The definition includes:
- [business] partners of the company and their spouses and children
- a trustee where the company controls the trust
- another entity or company, or an associate of that other entity or company, that has a sufficient influence or voting rights to control the company, or
- if due to the operation of the above a third party is an associate, another party that is an associate of that third party.
The definition of in-house assets contained in section 71 of the SIS Act (see above) will be amended by items 28 to 34 to extend the operation of the basic rule relating to investments in, or loans to employer-sponsors and to clarify the legal application of the restrictions. The definition currently covers assets that are a loan to or an investment in a standard employer-sponsor or an associate of the employer-sponsor. This will be widened by item 26 which will apply the in-house investment restrictions to:
- loans to, or investments in, a related party of the fund
- an investment in a related trust, or
- an asset subject to a lease or lease arrangement between the trustee of the fund and a related party of the fund.
The categories of investments excluded from the restrictions on in-house investments will be expanded by item 27 to include:
- if a fund is an excluded fund, business real property subject to a lease or other legally enforceable lease arrangement from a related party
- investments in widely held unit trusts (i.e. a trust where there are fixed entitlements to capital and income and less than 20 entities are entitled to 75 per cent or more of the capital or income of the trust), or
- property held by the trust and a related party as tenants in common where the property is not leased, or under a lease arrangement to a third party.
Other amendments to section 71 will tighten various definitions to include leases and lease arrangements.
Transitional periods are dealt with in proposed Subdivision D . Calculations under some of the amendments are relatively complex. Proposed section 71A provides that where a loan or investment was made prior to 12 May 1998 and did not breach the in-house investment rules applicable at that time, then the asset will not be considered to be an in-house asset under the new rules. However, if a payment on a share or a unit of a unit trust is made after 30 June 2009 the investment will partially lose this status. When calculating the value of the in-house asset to determine whether the in-house asset rule has been breached, the proportion paid after 30 June 2009 to the total amount paid, multiplied by the market value of the asset, is to be used ( proposed section 71A ).
Similarly, leases or lease arrangements with a related party and entered into or in force before 12 May 1998 will not be in-house assets ( proposed section 71B ).
Proposed section 71C contains transitional provisions that apply where an asset is invested in, a loan made or a lease or lease arrangement entered into after the 'test time' (ie. the time of the 12 May 1998 Budget) and would breach the in-house asset rules contained in this Bill. Such assets, loans etc will not be considered to be in-house before 1 July 2001 but will be after this time.
Proposed section 71D deals with the situation where an asset is acquired between the test time and 30 June 2009 and the purchase price of the asset does not exceed the amount of dividends or trust distributions received after the test time and before 1 July 2009 from an investment made before the test time or from investments made from dividends or distributions from the original investment. Where these conditions are satisfied the asset so acquired will not be an in-house asset. This will address situations such as where an investment is made prior to the test time and the returns from the investment are reinvested and will include, until 30 June 2009, income from the original investment and subsequent investment of income from that investment.
Proposed section 71E applies to funds with fewer than 5 members (excluded funds). If, after the test time and before 1 July 2009 such a trust makes an investment in a unit trust or a company which would be an in-house investment and, before this investment the trust already has an investment in the trust/company and the trust/company in which the investment was made owes funds to another entity other than the fund, the trustee may elect that proposed section 71E applies. If such an election is made and the value of the investment by the trust does not exceed the value of the loan amount owed by the company, then the asset will not be an in-house asset. If the value of the asset exceeds the amount owed, the proportion of the market value of the investment calculated in the same proportion as the amount of the excess to the purchase price of the investment is to be included in the calculation of the in-house assets held by the trust.
Application : The changes to in-house assets noted above will apply to the making of a loan or investment, or an asset subject to a lease or lease arrangement, made after test time (see above) [ subitem 45(3) ].
The primary policy objective of this Bill is to ensure that the investment practices of superannuation funds are consistent with the Government's retirement income policy. That is, superannuation savings should be invested prudently, co nsistent with the SIS Act requirements, for the purpose of providing retirement income and not for providing current day benefits.
Proceeding with the investment rule changes will limit the ability of funds to transfer assets to related entities that are not regulated by the SIS Act. The changes have the objective of ensuring that superannuation savings are safeguarded in the manner that was originally intended by the SIS Act investment rules and preserved for retirement purposes. The Government argues that failure to ensure this is expected to impact on longer term Budget outlays.
The risks from not implementing the changes will increase as the superannuation sector grows and matures. If the changes do not proceed, it will open the way to a major expansion of the practices that they address. An assessment of the impact needs to take account not only of the current level of particular practices but also the long-term cumulative effect of allowing such practices to expand and continue over a long period of time.
The rules concerning the acquisition of assets from related parties and leasing assets to related parties have exceptions for business real property. While there are risks involved in providing exceptions to the general rules, these exceptions have the benefit of allowing small business owners to use their superannuation savings to invest in their own business premises. The exceptions recognise that land and buildings generally have an underlying value independent of the employer-sponsor's business.
An alternative view is that there are no sound reasons for limiting the ability of superannuation trustees to invest in geared unit trusts. The Government's summary of the ISC survey and subsequent field work did not provide any examples of fund member’s superannuation savings being placed at risk, or evidence that investing in unit trusts produced poor investment returns.
Existing SIS Act requirements place obligations on trustees to invest prudently, for the purpose of providing retirement income and not for providing current day benefits. It is arguable that existing arrangements are adequate, given the lack of empirical evidence that Budget outlays are in jeopardy.
Further, as noted in the main provisions of this Digest, investments by trustees in widely held unit trusts (e.g. pooled superannuation trusts, investments made by life insurance offices and fund managers in wholesale investment vehicles) are exempt from the new investment rules. There appears to be limited rationale for this exemption. As explained in the background to this Digest, excluded funds/SMSFs, which account for 12 per cent of all superannuation assets, invest in more conservative investments than other superannuation funds, yet experience better returns. The Government believes that long term Budget revenue will be jeopardised if people investing their own money via better performing, lower cost funds are restricted in the types of investments they make. However, the Government does not believe that long term Budget revenue will be jeopardised if people investing someone else’s money, via comparatively poorer performing, higher cost funds are not restricted in the types of investments they make.
It is also arguable that the Bill will not achieve the Government's objective. The legislation does not acknowledge that closely held unit trusts are often used for non-gearing purposes. In addition, commercial or non-SMSFs will continue to be permitted to invest in geared unit trusts. The new rules attempt to close off superannuation fund trustees from investing in closely held unit trusts, but it will not end geared investments. Trustees of SMSFs will merely gear elsewhere, or else invest in widely held geared unit trusts.
It is also arguable that the Bill will not achieve the Government's objective of increasing the safety of people's superannuation benefits in the case of operators of excluded funds/SMSFs. The Superannuation Legislation Amendment Bill (No. 3) 1999, which was introduced into the House of Representatives on 31 March 1999, will require, among other things, all excluded funds/SMSFs to have fewer than 5 members where all members are trustees and there are no other trustees of the fund. With all excluded fund/SMSF members also being trustees, they will be bound by existing fiduciary duties of trustees. It arguable that is not clear that the members/trustees of excluded funds/SMSFs, who are responsible for the management of their own affairs, need to be prevented from making certain types of investments, because the Government believes those investments need to be made more safe. Operators of excluded funds/SMSFs include wage and salary earners, professionals, and the self-employed. Trustees of excluded funds/SMSFs adopt a far more conservative approach to investment than other superannuation funds, with considerably greater emphasis on cash and property, and far less involvement with equities and securities, that produce on average higher returns than commercial superannuation providers.
Arguably, the Government could be accused of favouring the commercial superannuation providers (such as banks, fund managers and life insurance offices) over the individual investor, small business owner, wage and salary earner, professional or self-employ ed person who runs an excluded fund/SMSF and produces higher returns than commercial superannuation providers.
An alternative view of the investment restrictions contained in the Bill is that they are an attempt to increase the safety of people's superannuation benefits. As noted in the background section, there is a tendency for some trustees to use investments in related entities, including trusts, to circumvent the investment restrictions currently contained in the SIS Act with resulting difficulties associated with the supervision of the ultimate use of superannuation moneys. Such activities can, on their face, be explained as investments that comply with the SIS Act and as a result it cannot be expected that such activities would appear in survey results, particularly those undertaken by the industry regulator.
The restrictions on in-house investments aim not only at preventing the early payment of benefits but also to ensure that superannuation assets are not excessively tied to the success or failure of an entity related to the members or, in particular, the employer-sponsor of a fund. Take, for example, a case where an employer-sponsor or their associate is a trustee of the fund and has effective control of the investment of the fund. The fund subsequently invests substantial amounts in the business of the employer-sponsor, principally through related parties. Unfortunately the business of the employer-sponsor is unsuccessful and ceases to trade leaving large debts to both secured and unsecured creditors. As a result the employees whose superannuation entitlements were paid into the fund lose not only their entitlements relating to leave and severance pay but also a substantial amount of their superannuation assets which were invested in the business.
While the above may be seen as an extreme example it is quite possible for such situations to occur under the current investment rules. While many small and medium sized businesses may regard employee superannuation funds as a potential source of investment funds it should be remembered that all investments contain an element of risk and that spreading of risks through a diverse investment portfolio is a major rule of investment even if it results in lower returns due to the lower risk.
- Australian Prudential Regulation Authority, Superannuation Industry at a Glance - March 1999 .
- Australian Prudential Regulation Authority, 'Focus on Excluded Funds', APRA Bulletin June Quarter 1998 , p 7. Data used in this section was obtained from this article.
- ibid., p 9.
- ibid., p10.
- Financial System Inquiry, Final Report, March 1997, p 333.
- i bid., 334.
- Explanatory Memorandum to the Superannuation Legislation Amendment Bill (No. 4) 1999, Regulation Impact Statement, p 5.
- The Treasurer, the Hon. Peter Costello, MP, Budget Paper No. 2. Budget Measures 1998-99 , p. 2-14.
- Assistant Treasurer, Senator the Hon. Rod Kemp, Grandfathering Arrangements For New Superannuation Investment Rules , Press Release No. AT/025.
- Assistant Treasurer, Senator the Hon. Rod Kemp, New Superannu ation Investment Rules , Press Release No. 19.
- Assistant Treasurer, Senator the Hon. Rod Kemp, New Superannuation Investment Rules Introduced Into Parliament , Press Release No. 038.
Chris Field & David Kehl
24 August 1999
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