Chris Malkin, Principal - Superannuation Audit

As of 1 July 2011 new rules came into effect governing investment in personal use assets and collectibles for SMSFs. The rules contain strict measures for holding and investing in these types of assets, and carry very severe consequences if broken, with little if any relief from penalties or discretion available to regulators.

What are Collectables?

Section 62A (SIS Act) defines collectables as follows ‘artworks, jewellery; antiques; artefacts; coins or medallions; postage stamps or first day covers; rare folios, manuscripts or books; memorabillia; wine; cars; recreational boats; memeberships of sporting or social clubs; or assetsof a particular kind... ordinarily used or kept mainly for personal use or enjoyment'.

The above definition was introduced with the new rules, to provide clarrity on what assets fall under the new requirements. However it is a double edge sword,a s simply having an investment in these types of assets - whether in good faith or not - bears the same responsibilites and burdens upon the trustees.

Why the Concern?

Historically the various regulatory bodies of Superannuation have often been uncomfortable with the holding of these types of assets within funds as they can often be perceived to carry a conflict with the section 62 - the sole purpose test, which simply states that a fund must be maintained for the benefit of providing for a member upon their retirement, death or disability.

The most recent ATO statistics (June 2011) indicate that collective values of artworks, collectables, metals and jewels inside self managed superannuation funds amounts to $623 million or 0.15% of the balance of all SMSFs.

In short the Regulators do not believe that investment in these type of assets are in the ‘spirit' of the rules.

What are the new requirements?

Regulation 13.18AA sets out the various requirements, as well as penalties which also apply if contravened, for those types of assets previously outlined.

The new requirements are as follows:

1. Item must not be leased to a related party. A related party is: a member of the fund, a relative of a member, an associate of a member, a partner of a member in a partnership, etc. Essentially this means that a member or related party is, for all intents and purposes, unable to derrive use of the asset. Whether a commerial fee is paid for the use of an asset is no longer an aceptable justification - eg artworks can not be stored at home or rented to a relative.
2. Item must not be stored in private residence of a member or a related party. This means that only professional commericial storage of these collectable and personal use assets can be used to keep the assets - eg classic cars will not be able to be stored in a back yard garage at the members residence.
3. A decision on storage must be documented - The specific location for storage will need to be documented under a formal resolution or included as part of the funds overall investment strategy. Documentation must be kept for 10 years.
4. Item must be insured in the funds name. This introduces three new rules, firstly a formal requirement for an insurance policy to be used - no longer can the trustees decide to ‘self insure'. Secondly coverage under another partys home and contents or general business premasis insurance is no longer adequate. Specialist coverage must be purahcse by the fund for the asset, with the fund owning the policy. Thirdly there is 7 days to have this coverage in place from the date of purchase.
5. Item must not be used by related party.
6. Transfer of asset to related party requires independent valuation. This introduces a requirement to use a qualified independent (licensed) valuer to determine the proper price at which such an asset can be passed out of the fund to a member of the fund or related party of a member. A transfer can include either a sale of the asset, disposal of the asset as a withdrawal, or a swapping of the asset for another of equal value.

What relief is available?

It is important to point out that for the new requirements are split out into two distinct groups to which the rules apply. First grouping is of collectable and personal use assets already held in the fund prior to 1 July 2011 and the second group is to for personal use assets and collectables purchased on or after 1 July 2011. The importance of these two groups is the date at which the new rules apply. For assets held prior to 1 July 2011 no action is necessary until 1 July 2016, but any assets purchased on or after 1 July 2011 the new rules apply immediately.

Finally there is a small list of exemptions to the above rules which is extremely limited and most likely not to apply in the large majority of cases.

What Penalties apply?

The regulations perscribe that an offence is a strict liability offence and that for a breach of any and each of the requirements, 10 penalty units (penalty unit = $110) applies. This merans that there is no descretion in applying penalties - if a breach occurs intentional or accidental the regulators must issue a penalty of the amount determined in the rules, ie $1,100 (10 x $110)

The most concerning fact about the way in which the rules are written is that these penalties are per breach, per individual item!!

In practise

Consider the following:

Fred and Wilma have a self managed fund and nearing their retirement and have a self managed superannuation fund - The bedrock Super Fund. They have accumulated about $550,000 for their retirement. Recently they started collecting nice wines to enjoy upon their retirement. They had typcially purchased these wines as they visited wineries. Since 1 July 2011 Wilma and fred have been busy at work so have only had the chance to take 1 trip and purchased 1 dozen wines within the Bedrock Super Fund, Fred and wilma keep these at their home with there other wines collection under the stairs.

At the end of the year Wilma and Fred have their accounts done and annual returns prepared. As part of the annual return the The Bedrock Super Fund must undergo an audit. During the audit it is discovered that the following breached have occurred;

• Items have been stored in the private residence of a related party (Fred and Wilmas home);
• Decisions on storage have not been documented;
• Items have not been insured in the funds name within 7 days;

Given that each breach gives rise to 10 penalty units, that's 30 penalty units which apply, right?

Wrong!!

30 penalty units apply but because the breachs are per item and fred and Wilma purchased a dozen wines, then it is 12 x 30 units or 360 penalty units which apply.

At $110 a penalty unit, that's a grand total of $39,600 or some very expensive wines!!