Don't panic! ATO letter rattles SMSF trustees

This article was current at the time of publication.

Back in the late 1970s, says Morrows Group director and chairman Murray Wyatt FCPA, there was a special rule from the Australian Taxation office (ATO) for trustees of self-managed superannuation funds (SMSFs). It said 50 per cent of the fund’s investment had to be split between state and federal government bonds.

Then, interest rates began to rise, and the capital value of bonds began to tank.

“Suddenly there was a situation where the government was legislatively being prescriptive for you to invest in an asset class that was collapsing,” Wyatt says.

That is certainly not the case today. However, the letter that was sent from the ATO to 17,700 SMSF trustees in August, one that made mention of an “administrative penalty of A4200 if your investment strategy fails to meet these [diversification] requirements”, has Wyatt thinking back to the old days.

The letter went to trustees whose SMSFs, the ATO believes, hold 90 per cent or more of their funds in a single asset class.

“When the ATO sends out a letter like this, depending on who’s seeing it and reading it, it can be read as being prescriptive,” Wyatt says.

“Diversification is not necessarily a risk protection measure because you’ve got to look at the correlation between the asset classes.”

In recessionary times Wyatt says diversification won’t necessarily save you.

“You’ve got to be underweight in those assets that are going to be affected by recessionary times, like equities and property, and overweight in those asset classes that are protective, like cash, bonds and market-neutral hedge funds,” he says.

The most important message for those who receive this ATO letter is not to panic, Wyatt says.

Paul Drum, CPA Australia’s former head of external affairs, agrees.

“‘Don’t panic’ is very good advice,” he says. “Some might say the letter has an unfortunate tone about it. Clearly it is meant to be a terse warning.”

Such a letter has not been sent to SMSF trustees in the past, so it is understandable that some might be shaken. However, this letter, Drum says, is simply reminding trustees of their obligation to consider diversification, and the potential risks involved with inadequate diversification.

Raising awareness of investment strategy obligations: ATO

Even the government is downplaying the letter, with then-senator Mathias Cormann in the Senate on 11 September describing it as the “… recent ATO correspondence in writing to approximately 3 per cent of SMSF trustees and their auditors who had invested 90 per cent or more in a single asset or asset class and had used a limited-recourse borrowing arrangement to acquire that asset”.

“The ATO’s intention was to raise awareness of investment strategy obligations,” Cormann said.

Less-diversified SMSFs with limited-recourse borrowing arrangements, he explained, are exposed to asset concentration risk. This means that in the event of a drop in the asset price, the funds could suffer significant loss.

It all seems to add up to the regulator using a terse letter to remind trustees of their obligations around SMSFs, Drum says. The negative side of the mail-out is if trustees make investment decisions as a direct result of the letter, without seeking advice and without considering their long-term wealth plans.

“It shouldn’t be treated in a light-hearted way,” Drum says. “It provides, if nothing else, a catalyst or an opportunity for members of the profession to have a discussion with their client. It’s a chance for them to invite their client in to have a look at their investment strategy.”

That’s the real advantage an accountant or adviser has, Wyatt says – they know their client. Where the ATO is sending out this letter to individuals the data says are not diversified, an adviser knows whether they are diversified outside their SMSF. They also know what other financial interests are in play, and what are the hopes, dreams and risk profiles of the fund members.

In other words, the adviser knows the context, and that is often the single most important ingredient in the planning of financial success.

“We write all of this up as part of our consideration of the risks before developing a suitable investment strategy, so we understand the way this letter should be treated,” Wyatt says. “But to an unsophisticated investor, getting a letter from the ATO is daunting.”

Keith Clissold FCPA, principal of H.G. Mayer & Co., says the threat of a fine appears to be the main catalyst for angst in the community. If a trustee disposes of a property as a result of the letter and before seeking advice, then the ATO should help to rectify the situation, he believes.

“My thoughts are that as long as the fund can meet its current obligations, e.g. tax, audit and accounting fees, pension payments – then it should not matter,” he says. “As a trustee, I would hope my fund invests wisely.

“Investment should be in line with a strategy normally developed between the trustees and their financial adviser. Again here, the adviser and accountant … should advise the trustees to see if their fund is meeting its regulatory requirements and following its investment strategies.”