WHY CAPITAL GROWTH IS AN ESSENTIAL PART OF AN INVESTMENT STRATEGY

Residential real estate in Australian capital cities and large regional centres has been an attractive and relatively secure option for investors for many years. Steady and continuous economic growth for 29 consecutive years was reversed only by the pandemic. Tax incentives such as negative gearing opened up investment in real estate to people who might not otherwise get the opportunity.

There are two factors that need considering when investing in real estate. The first is the rental income that can be gained from sound property management and good tenants. The second is capital growth which occurs as the value of the property increases over time. Choosing one over the other is not a simple decision and often depends on individual circumstances.

Regular rental income is important to investors who are relying on the net income to assist with the mortgage repayments on their investment property. Any shortfall would usually be made up by the owners out of their own funds, so the longer the property remained without a paying tenant, the more difficult their financial position could become unless they had considerable alternative resources.

Capital growth is a long-term proposition as it is something that occurs largely due to market forces. Economic conditions, fluctuations in supply and demand, an increase or decrease in the population of a certain area and other demographic shifts are events which are out of the control of the investor. The only thing they can control is the condition of the investment property. Regular maintenance, improvements and renovations keep it in good condition, allowing it to increase in value.

Prudent investors enter the property market on the understanding that they are embarking on a long-term strategy. Historical data shows that the capital growth to be had by holding a property for as long a time frame as possible will far outweigh the value of the rental income over a corresponding period of time. However, for some investors, an immediate injection of rental income may be part of their own, albeit short-term, strategy.

Property investment is a popular wealth-creating strategy, not only among the general population but also for the trustees of SMSFs (self-managed superannuation funds). While they are also looking for rental returns, their focus is long-term as they build sound foundations on behalf of their fund members.

Fund trustees also carry the responsibility of the reporting requirements necessary to keep their funds compliant with ATO (Australian Taxation Office) requirements. This is in addition to managing the fund investment portfolio. However, many fund trustees are now turning to companies like SMSF Assure that specialise in managing the administration tasks on behalf of their clients, allowing the trustees to keep their focus on fund investments.

IS AN OVERSEAS PROPERTY INVESTMENT A POSSIBILITY FOR AN SMSF?

Trustees of SMSFs (self-managed superannuation funds) have, for some time, been able to purchase residential property in Australia on behalf of their fund. Although our property market may be “coming off the boil”, prices are still high, and many SMSFs are looking elsewhere to build retirement income.

Interest in overseas properties has been a hot topic in the media lately, especially in parts of Europe where the long-term effects of the global downturn are still being felt, and property prices are low. Some cashed-up Australians are taking advantage of this situation; however, does this mean that trustees of SMSFs can also invest fund money in overseas property?

The current advice is that there is nothing to stop an Australian SMSF from acquiring property abroad, but continued compliance with our tax laws still must be considered. Here, the key issue still, is whether an overseas property investment meets the sole purpose test, along with some other factors that need to be checked and addressed.

The sole purpose of superannuation is to provide retirement benefits to members and beneficiaries of the superannuation fund. Provided the trustees or members do not use the overseas property for their own benefit prior to retirement, such property should meet the sole purpose test.

Before going any further, it would be wise to check that the trust deed allows for overseas investments. Most deeds do, but a quick check will allow you to proceed with certainty. You should also ensure that the purchase of property abroad is also included in your written investment strategy, with a thorough description of how you intend to make money for the fund. This should also include insurance to protect the investment.

Thoroughly investigate any legal compliance issues before committing any funds to this type of investment. For example, because SMSFs are a uniquely Australian vehicle, do not assume that our laws and rules will apply outside of the country. Here, the SMSF trustee is legally required to hold the title to the property. This may not be the case elsewhere and, in fact, it will vary from country to country.

Some foreign countries do not recognise our trust structure for SMSFs, and many do not allow a foreign entity to hold property directly. As a result, you may be required to set up a limited liability company in a foreign country and open a bank account in its name. It is the limited liability company that purchases the overseas property and the SMSF then invests in shares in that company. This will have tax implications both here and overseas, so make sure you check these out before proceeding.

There will also be additional costs involved, as there is no getting around the Australian Tax Office (ATO) audit requirements for SMSFs. This may involve having to hire a local accountant in the country of your investment to assist with tax and auditing issues. This will be an additional cost on top of the audit costs here in Australia.

If you do your research and purchase an overseas investment property, knowing all the costs involved as well as the legal, compliance and tax requirements in both countries, there is no reason for you not to proceed. Like any other investment, do your research, balance risk and reward, so that your fund may have a very lucrative asset working for its members.

DO YOU KNOW THE NEW PENALTIES SMSF TRUSTEES AND DIRECTORS FACE?

Industry and retail superannuation funds have been in the spotlight now for many months as the federal government tries to get their proposed legislative changes through parliament. These changes include the possibility of jail terms of up to five years for super fund directors who contravene the rules governing the fund.

Currently, this behaviour is not an offence and does not attract a criminal or civil penalty. The proposed changes would see the fund possibly subject to a civil penalty, which could then result in both civil and criminal consequences. For serious breaches of a director’s duty, a criminal offence and jail time is proposed.

These proposed changes affect directors of industry and retail funds, but are there any changes taking place that affect self-managed superannuation fund (SMSF) trustees and directors? Yes, there are, and they are already impacting on the SMSF industry.

For example, harsher fines have been in place since the beginning of the 2017/2018 financial year, with the value of a penalty unit increasing to $210 since 1 July 2017. What are penalty units? This is the amount of money under Australian law that is used to calculate penalties for breaches of statute law. It is easier to change the number of penalty units each year than it is to amend legislation to increase penalties.

SMSF trustees need to understand how penalty units work, as they must operate their fund according to superannuation rules. If they break those rules, financial penalties may be the result. A breach of certain rules means an automatic administrative penalty ranging from $1,050 up to $12,600, depending on the type of breach.

Three types of new penalties have been imposed. One is a requirement to improve a trustee’s knowledge through education by taking a course by a certain time. Failure to do this will incur a financial penalty. The second is to correct any breaches of the rules within a specific time frame. In both cases, evidence must be provided to the ATO to prove that corrective action has been taken.

The third is the administrative penalty already mentioned and it is the most significant. Fines will be applied to each trustee separately, so if there are two trustees, the fine must be paid by each individual trustee, for the same amount, effectively doubling the amount of money to be paid. If the SMSF has a corporate trustee, the directors are jointly and severally liable to pay just one penalty amount.

These fines must be paid by the trustees or directors themselves and cannot be reimbursed back to them out of the SMSF funds. The consequences of overlooking an administrative responsibility are now significant, so using a specialist such as SMSF Assure to handle all administrative and compliance matters makes more sense than ever.

DIVERSE INVESTMENT OPTIONS AVAILABLE TO SMSF TRUSTEES

As the trustee of a self managed superannuation fund (SMSF), you are responsible for the investment decisions the fund makes on behalf of its members. This is a big responsibility, as errors of judgement will have a big impact on the lifestyle of the fund members upon retirement. For this reason, investments cannot be ad-hoc, but must be part of an investment strategy.

This strategy should be in place before you actually make any investments. It should also be in writing and have clear objectives. Without it, you are following the vagaries of the market instead of treading a path that will eventually see those objectives reached or exceeded. Like any strategy, it must be reviewed regularly, and any adjustments and decisions should be recorded. You may need to explain them at some time in the future.

In terms of how to invest through your SMSF, there are some restrictions imposed by the Australian Taxation Office (ATO), but generally, you are able to invest in shares, property and collectibles. However, it appears that fund trustees have different priorities in their investment packages than Australian Prudential Regulation Authority (APRA)-regulated funds.

Statistics released by the ATO show the comparison between SMSFs and APRA-regulated funds as at 31 December 2017. This reveals that APRA-regulated funds have much more diversity in their investments than SMSFs, which concentrate more on cash, property and alternative assets.

For example, SMSFs hold 23% of their investments in cash, 1% in international shares and shares in unlisted companies, 15% in property and 28% in “Other”, which includes trusts, managed investments and collectibles. For APRA-regulated funds, cash makes up just 11% of their portfolios, 24% in international shares and shares in unlisted companies, 8% in property and just 4% in “Other”, which for them includes hedge funds.

Speculation is that SMSF trustees like property because they are familiar with the Australian property market, which has generally performed well for some time. They are also comfortable with holding cash in the safety of our banking system, even though returns have been somewhat low since 2008. Their lack of knowledge about international shares makes them wary of investing there.

Many SMSF fund trustees have handed the administration of their funds over to companies such as SMSF Assure so that they can concentrate on building their investment portfolio. However, there are also many licensed financial advisors who could help them rework their investment strategy to take advantage of opportunities they may be missing. These decisions now may affect the members’ quality of lifestyle in retirement, so getting professional advice should at least be considered.

Protect Your SMSF Assets Against Fraud

According to the Australian Taxation Office (ATO), self managed superannuation funds (SMSFs) held $700 billion in assets as at 30 June 2017. This sector of the superannuation industry has grown steadily and where once the number of funds was counted in the thousands, the ATO advises that there are now more than one million SMSFs, holding almost 30% of the asset value of the $2.2 trillion superannuation sector.

This growth and popularity of SMSFs is fuelled by the desire of many investors to have more control over where their superannuation contributions are invested. However, it may prove to be a double-edged sword if SMSF trustees do not heed the warnings from industry experts to be wary of becoming victims of fraud.

ATO figures show that in the last 10 years, $30 billion has been lost by SMSF trustees and members through fraud and financial misconduct. However, one superannuation research firm suggests that the true losses could be more in the range of $100 billion when the loss of investment returns is factored in. This is very concerning, and fund trustees should be looking at these figures with alarm.

A major issue for SMSF trustees is that there is no compensation scheme available to them should they fall victim to bad advice or deliberate fraud. APRA, the Australian Prudential Regulation Authority, oversees the safeguards in place to protect the assets of regulated funds, which include not-for-profit industry funds and for-profit retail funds.

These trustees can apply to the federal government for compensation on behalf of the members if money is lost through theft or fraud. This compensation scheme is funded by an industry levy on large funds, but no such scheme exists to benefit SMSF trustees and members.

The few avenues open to SMSF trustees come with restrictions. The Financial Ombudsman Service will accept complaints from SMSF trustees who have received bad financial advice, and while the service is free, there are monetary caps in place. Financial planners are also required to have professional indemnity insurance, but this could be a long road for an SMSF trustee as there are exclusions and caps and it would likely require a lengthy legal process with no certainty of success.

SMSF trustees must exercise care when choosing who they approach for financial advice. The integrity and reputation of the advisors will be just as important as their track record, but there are a few things the trustees can do to reduce the risk. One issue they should put to rest first is to secure the services of a reliable company like SMSF Assure to look after the administration and compliance of their fund, so they can concentrate on protecting the investment side.

A good place to start is to ignore over-inflated claims about likely returns and remember that if something is too good to be true, leave it alone. Beware of high pressure sales pitches, and if a scheme is too complicated to understand, give it a miss. Protect yourself by investing in a range of asset classes, and regularly monitor them to check their performance. Lastly, only work with advisors who disclose incentives that they receive from third parties and who will advise conflicts of interest when they make recommendations.