Shaun Backhaus from DBA Lawyers said the Merchant case highlights the importance of understanding the superannuation law obligations and how they apply to investment strategies in an SMSF.
In May, the Administrative Appeals Tribunal (AAT) overturned a decision by the commissioner of taxation to disqualify a person from being an SMSF trustee despite being found to have breached superannuation laws and the anti-avoidance provisions of the Income Tax Assessment Act (ITAA) 1936.
The AAT ruled Gordon Merchant, the founder of Billabong, could continue acting as an SMSF trustee after the tax commissioner originally disqualified him from doing so in October 2020.
The disqualification followed claims by the ATO that Merchant, as a director of the corporate trustee for the Gordon Merchant Superannuation Fund (GMSF), had overseen contraventions of the Superannuation (Industry) Supervision Act regarding the fund’s acquisition of shares from a controlled discretionary trust to realise a capital loss.
“Most people are aware of what the super law says regarding SMSF and investing, that is an SMSF must formulate, review and give effect to an investment strategy. This is one of the prescribed standards to which an SMSF must comply and is contained in section 34 of the SIS Act,” Backhaus said.
“Administration penalties can be applied for not complying with this and if a trustee intentionally or recklessly contravenes that, it can be classed as a higher offence with higher penalties.”
He said the covenants in the SIS Act are included in all the rules that apply to an SMSF, that firstly there has to be a regular review of an investment strategy, especially regarding cash flow requirements and diversification.
“Diversification is a big part of the SIS Act. It states in Section 52B (2)(f) (ii) that ‘the composition of the fund’s investments as a whole including the extent to which the investments are diverse or involve the fund in being exposed to risks from inadequate diversification’,” he said.
“And that consideration must also be given to ‘the liquidity of the fund’s investments, having regard to its expected cash flow requirements’ as well as ‘the ability of the fund to discharge its existing and prospective liabilities’.”
He added that in a big APRA fund, where people might have started their pensions and are expecting to live on those, the trustee rightly needs to think about what members are in the pension phase, and what members are likely to start pensions and plan for that.
“However, in an SMSF it’s a little bit more artificial because the member who’s already receiving their pension is almost always going to be a trustee or director of the corporate trustee,” Backhaus said.
“And the cash flow requirements aren’t just pensions. They can have to pay back loans the fund has. For this reason, it doesn’t make much sense to an SMSF to be as worried about this because it can cease their pension as happened in the Merchant case.”
He continued that there were several key takeaways from the Merchant case of which SMSF trustees and their advisers should be aware.
“The first one is that investment strategies matter and what is written in them matters. The courts will delve into the words written and evidence surrounding an investment and trustees need to know what is in the strategy, consider it, and follow it,” Backhaus said.
“With any strategy, it is important to also have contemporaneous documentary evidence about the reasons for investment decisions. Strategies can be changed, it is not about the content, but whether it is being given effect.”
He added that it is also best practice to not just do a yearly review of investment strategies but to remember any investment should be in line with the overall strategy of the SMSF, especially any big or new investments that have some risks.
“If clients are not engaging with these strategies, and giving effect to them, they are at risk and the adviser is also at risk.”
