Now I really know SMSFs are out of control

I’ve been dropping in on some SMSF seminars lately. At the start, I was amazed. Now I’m aghast.

My amazement sprang from the attendance at these seminars. I went to a widely advertised seminar series targeting members of collective funds, where there were 60 attendees (and this firm runs hundreds of seminars annually). At a recent seminar targeted at industry professionals, there must have been 400 people there, primarily financial planners and accountants.

I’m aghast at some of the SMSF investment strategies discussed at these events. Let’s just say that portfolios of managed investments and blue chip shares did not exactly figure prominently. Rather these seminars are often about moving real estate and a wide range of non-conventional assets – generally intertwined in some way with a trustee’s personal circumstances or business – into SMSFs, frequently with the use of gearing and structuring.

The below example (which I’ve made up) gives you a flavour:

John has $500,000 in his industry super fund. He owns a construction firm and wants to buy a new crane, costing $2 million. But it’s hard to get finance for his firm right now. He would also like to minimise his tax bill. How can he buy the crane and cut his tax?

You might well have thought this looks somewhere between difficult and impossible, but in fact it’s no problem:

– John establishes an SMSF and transfers his balance out of his industry fund.
– His SMSF borrows $1.5 million.
– The SMSF invests $2 million into a unit trust which buys the crane and leases it back to John’s company.
– Revenue generated by the crane now flows to the SMSF via the trust, which pays tax on net income at 15%, rather than 30% in the company.

As hard as it is to believe (and we are neither legal nor tax advisors), apparently this does not technically contravene any of the following:

– Sole purpose test
– Investment strategy requirements
– Part IVA tax avoidance

What really horrified me was this – despite the large audiences, I’m yet to see one person raise their hand to ask whether there might be a problem with any of the regulatory frameworks above.

This may have something to do with another benefit which is often proposed to accountants and planners – how SMSFs can be used to increase fees. So much for SMSFs as a way of avoiding the costs of the collective system.

As we’ve consistently stated, SMSFs have a legitimate place in the market for certain member segments. But is the boundary between collective funds and SMSFs in the right place?

If strategies such as the above are indeed permissible, we’re surely starting to miss the policy forest for the trees, and setting the stage for future disasters. Exotic assets, gearing, and structuring have been at the heart of many of the industry’s catastrophes.

Many SMSFs do indeed have straightforward portfolios of conventional investments. But there has been a series of policy mistakes by government such as permitting gearing in super, and a missed opportunity to rein in SMSFs via the Cooper Review. This has opened the floodgates to a situation where it’s now seen as ok for an SMSF to have a strategy which is exotic, highly geared, and implemented via compllicated (and expensive) structure.

We need some better boundaries – not least for the protection of SMSF members themselves.