Tactical Super director Deanne Firth told SMSF Adviser the ATO’s approach to its diversification review had unduly scared clients, who were often concentrated in one asset because of their concerns around taking risks in investment.
“The ATO letter sent to trustees finishes with, ‘You should be aware that if your auditor identifies you have failed to rectify any non-compliance with the requirements listed above, this could result in the imposition of abovementioned penalties’,” Ms Firth said.
“The ‘fail to rectify’ implies their current investment strategy is wrong, but there are many reasons trustees have more than 90 per cent of their assets in a single asset class.”
Ms Firth gave examples of recent clients who may fall under the ATO’s sights in its diversification review, including a couple who had purchased their business premises in their SMSF when it came up for sale and an elderly trustee who held her entire assets in cash out of fear of sharemarket declines following the global financial crisis.
“Many funds with 90 per cent in one asset class have considered diversification and their investment strategies do not breach regulation 4.09,” she said.
“Regulation 4.09 asks you to consider diversification, not to be diverse. Similar to the insurance consideration, an SMSF doesn’t have to hold an insurance policy for its members, it just has to consider whether they should.”
Ms Firth said a key concern for auditors in relation to the strategy review was that while clients were coming to them with questions around the viability of their investment strategy, they were not legally able to comment on whether the client’s asset allocation was sufficient.
“If you don’t have a financial services licence, you can only provide factual information about investments and strategies,” she said.
“You cannot prepare or review an investment strategy for an SMSF. This means trustees cannot bring their investment strategy into their accountant for them to review to see if it complies.”
She said a best practice approach for auditors involved considering that diversification needed to be covered off in an SMSF the same way that insurance had been when it was under the regulatory microscope several years ago.
“I believe all that is required is a paragraph similar to what was added for the insurance consideration, so that it is clear that in preparing the strategy, the trustee has considered diversification, the risk of inadequate diversification, the likely return from investments, cash flow considerations and liquidity,” Ms Firth said.
“The legislation doesn’t actually require a written investment strategy, it just requires the trustees to ‘formulate, review regularly and give effect’.”
If investments must be diversified as the ato letter incorrectly claims well then there are 3 main asset classes cash property equities. Is the ato saying it is compulsory for every smsf to hold a property?
No one is suggesting Accountants or Auditors influence to change an IS, they just do what they do with other aspects of SMSF compliance, check the actual against the purported and, if out of line, the Trustee needs to correct which, in reality is the IS. The document must mirror the implemented strategy as well as explain the thought process to arriving at it
Dear Assistant Commissioner, you letter is not fairly written and is mischievous. There is no requirement to diversify and you have admitted that; however, the letter from you office states whether the diversification requirement has been met. You should probably quote the relevant clause of reg 4.09 so that the trustees reading it knows that there is no requirement to diversify. In fact, it would appear to be a deliberate attempt to push the legislative intent, when there is not one. I would love to see the Commissioner impose this penalty and the trustee appeal to our tribunals/Courts. I would not think any judge will involve themselves to activism that is displayed by the ATO. The Commissioner administer the law, not make the law. Please remember. Making the law is left to the Parliament, and there is a reason for that. The relevant Minister should be informed, and ask to justify the Commissioner letter of acting ultra vires.
I have no issue with the line the ATO has taken on this matter. In the past 3 day, I have qualified 3 audits on this matter. The issue in not whether the fund has diversification of assets, it is that the fund’s investment strategy has not explained why they have chosen not to have a diversification of assets. Using the ATO’s 90% rate, I could state that it is close to that number of fund’s that I audit where the fund has a template investment strategy just produced by the accountant with no consideration to the actual objectives of the SMSF. In fact, those investment strategies serve no purpose and really have no need to exist.
I do feel that the line by the ATO is not really clear, but I see the intent. I now see the auditor’s role in reviewing the investment strategy is A) Does the fund actually have an investment strategy; B) Does the fund invest in accordance with the strategy & C) Has the trustee explained, in the investment strategy, why they have chosen to invest in that manner. If I can answer yes to each of these, no issue. It is generally C), and to a lesser extent B) that is the issue.
I must also add that in my audit management letters, I do include a paragraph stating that as auditor, I am neither authorised nor qualified to assess as to whether the investment strategy meets the needs of the members. I am simply forming an opinion as to whether the strategy provides a yes answer to the three questions.
Many of my SMSF clients have invested in property and over the years the market value of property has gone up by over 200-300%. In a court of law ATO will never win.
Total agree with your comments Assistant Commissioner. However you are the sledgehammer to the walnut. Is it the ATO suspects there are deficient IS out there? If so, a focus to the auditors to remind them of their duty to ensure compliance. A letter detailing the penalty and implying there is an inadequacy is terrifying to Trustees. Maybe you could enlighten us (as we put these fires out) what the end that you are trying to achieve is, what mischief are you remedying?
To the Assistant Commissioner: an IS is mandatory from day one! What the situation here is that it is all about justification: No one can tell a trustee how or where to invest. The ATO always trots out the sole purpose test but doesn’t mention how this can be achieved. If the trustees have sat down, discussed the situation and DOCUMENTED what they have done. no one can tell them that they are wrong. If that was the case, the affect for the trustees of most public funds, would be disastrous. Once the IS has been formulated and DOCUMENTED, the trustees review it as often as they think fit, document the review and the issue has been addressed. ““Regulation 4.09 asks you to consider diversification, not to be diverse” says it all. But be sure to document everything.
Thank you for your input Dana however it is my understanding that trustees under section 52(6)(c) trustees only have to “offer” investment options which will allow a member to be diversified but if the member chooses to be undiversified then the trustee has no obligation to assess whether this is appropriate! So in short, this whole exercise really comes down to ensuring the Investment Strategy template being used by the members allows them to put ranges in for different types of assets classes thus the choice being theirs.
I think Practitioners need to avoid ducking and weaving on this one. It isn’t a case that the Accountant or Auditor can’t comment on the IS. They can read it and test if r4.09 is satisfied. An AFSL is not required to observe that an IS states one think but the asset allocation is out of line. For example, IS states that liquidity is required to fund annual pension payments as no members are able to contribute etc, whereas, the asset allocation is skewed to illiquid (growth) assets that don’t pay income.
On the otherhand if the fund has a lumpy asset allocation whereas the IS states a free ranging ‘any asset class, any percentage’ type of strategy, the IS is clearly not addressing the design of the actual strategy. The IS should state what the objectives of the asset allocation are and how they are appropriate for the membership profile, etc.
I think the message is, the IS is not a compliance document, it should be meaningful and therefore, designed for the individual fund it applies to
Very good concise commentary. However is this whole issue another example of insto lobbying? Who actually owns this issue at the ATO?
Whilst Deanne makes some good comments around how it is possible to still have a suitable investment strategy with 90% in a single asset – our letter does not suggest that you can’t. It simply reminds Trustees in this situation that they must be able to demonstrate why they are comfortable this meets their retirement goals and how they are comfortable they have addressed the legal matters required in regulation 4.09 of risk and return, liquidity and inadequate diversification. I would suggest that it’s very hard to evidence this with without a written investment strategy and any auditor worth their salt will ask for one – so Trustees would be best served to have their investment strategy in writing.
Your letter does not “simply remind trustees”. It is rude , threatening and heavy handed. I had so many trustees ring me scared and afraid they had done something wrong. The ATO has way too much power and urgently needs oversight.
Assistant commissioner. Our lawyer has suggested that the investment strategy is not legally required to be in writing. He has stated that as long as those considerations in the Regs have been addressed that’s all that can be required. “any auditor worth their salt” are you serious, We have rang ASIC and they have stated the discussions around diversification is paramount to financial advice and to be very careful as if that conversation influences the trustees to alter their investment strategy then it is “absolutely” financial advice.