Posted by the ATO : 24/06/2019 here.
“An ATO perspective on current tax and super issues for large superannuation funds”
2019 National Superannuation Conference
Hoa Wood, a/g Deputy Chief Tax Counsel
Robert Thomson, Assistant Commissioner, Public Groups and International
29 August 2019, Four Seasons Hotel, Sydney
(Check against delivery)
When compulsory superannuation was introduced over 25 years ago, it would have been difficult to anticipate the significant contribution this sector now makes to the Australian economy. As at March 2019, the value of assets held within superannuation totalled approximately $2.8 trillion with around two-thirds held within large superannuation funds (APRA Quarterly Superannuation Performance Statistics, Key Statistics, March 2019. Australian Prudential Regulation Authority, Sydney, issued 28 May 2019, apra.gov.au).
Current government policy settings including mandated contributions and concessional tax rates will continue to promote growth in this sector. With this level of investment and subsequent oversight by regulators, we recognise that funds operate in a complex and challenging environment as they seek to act in the best interests of members and meet their tax, reporting and other regulatory obligations.
Through our engagement with the sector, we have seen the different ways funds are responding to these challenges and continually evolving in the way they do their business and interact with their members and regulators, including the ATO.
We have observed the investment behaviours of funds changing as they seek alternative investment structures moving away from concentrated domestic markets to seek exposure offshore. We see funds adopting new technology directly or through service providers to process the significant number of daily investment and service related transactions. We also note that the service offerings of funds continue to evolve as they seek to remain competitive in this growing market.
In response, our responsibilities and services have expanded to support funds and their advisers meet their obligations and undertake assurance activities that builds community and government confidence in this sector.
We welcome the opportunity to provide an update on our engagement with large superannuation funds over the last 12 months. This paper will provide insights into some of our important initiatives such as the Justified Trust Program and a snapshot of our key areas of focus.
Engagement with the ATO
Large superannuation funds interact with the ATO in a number of ways. Our interactions range from supporting funds to meet their tax obligations as well as member reporting obligations which are fundamental to the administration of the broader superannuation system.
Over the last 12 months, we have extended our engagement with funds through our Justified Trust Program where we seek an understanding of a fund’s operations and economic activity to obtain a level of confidence that their tax obligations are being met.
In undertaking this work, we interact directly with funds, their advisers and increasingly, their service providers that funds employ to undertake investment activities, process data and report to the ATO either through the fund’s income tax return or events based reporting.
As we move away from an annual member contributions statement reporting system, we recognise that the transition to event-based reporting and bedding down of systems has been a significant development for industry over the last 12 months. Event-based reporting brings greater insight into fund’s reporting systems and processes as well as providing us with a more timely view of members’ attributes and contributions.
Transactions now reported to us have been in the order of over 32 million reports of member accounts or changes and 183 million reports of account contributions or transactions. This information now allows us to share this account and transactional information back to fund members though ATO online services.
For further information see Reporting obligations
Successor fund transfers
Last financial year, we supported funds through 16 successor fund transfers that involved approximately 1.2 million members, all or some of whom had the potential to be impacted in some way.
Looking ahead we’ll continue to support funds going through a merger or successor fund transfer (SFT). With the likely increase in this activity, we are updating our SFT protocol document following input from funds. We will provide further updates as we finalise these changes.
To keep up to date see Updates on APRA fund guidance
As part of the Tax Avoidance Taskforce, the ATO has been engaging with some of Australia’s largest taxpayers through the Justified Trust Program. Justified trust is an OECD concept that intends to build and maintain community confidence that taxpayers are paying the right amount of tax. The way that we achieve justified trust is by seeking objective evidence that would lead a reasonable person to conclude that a particular taxpayer paid the right amount of tax.
This is quite different to the risk-based approach of engaging with funds through compliance activities undertaken in the past. Justified trust requires a holistic understanding of the taxpayer and their business. It also requires obtaining a higher level of assurance than only confirming that a certain risk does not arise.
For more information see Justified trust
The justified trust approach was initially applied to funds in the Top 100 population. The Top 100 population consists of public and multinational businesses and large superannuation funds that have substantial economic activity related to Australia. As these entities have a significant impact on the health of our tax system, we engage with them one-to-one to manage their compliance and obtain a level of assurance over their economic and tax affairs.
For information on our Top 100 Program see Top 100 risk categorisation approach
Top 1000 reviews
The justified trust approach is also applied to funds in the Top 1000 population. The Top 1000 population consists of public and multinational businesses and large superannuation funds with annual turnover above $250 million. It does not cover taxpayers that continuously engage with us through our Top 100 Program.
For general information on our Top 1000 Program see Top 1,000 Tax Performance Program
Reviews of large superannuation funds in the Top 1000 population commenced in February 2019 and we expect to review approximately 82 funds through this program.
Our assurance team engage with each fund through streamlined assurance reviews (reviews) that typically cover the last four income years. We seek to apply a consistent, structured approach that has been tailored having regard to the unique business profile of large superannuation funds and their reliance on automated systems and third party service providers. This includes:
- Data driven assurance – we seek to assure aspects of the income tax paid by funds using data. Data sources used included income tax return and member contribution data, as well as audited publically available data such as data reported by funds to APRA. Where we have been able to assure aspects prior to engaging with a fund, our questions will be limited to confirming our assumptions or requesting explanations of outliers or variances.
- Governance over third party data – due to the necessity of outsourcing in the institutional investment environment, large superannuation funds rely on data from third party providers. Tax governance for superannuation funds therefore requires an assessment of the controls and processes in place to reduce the risks of reliance on third party data. Refer to Managing Tax Risks
- Tailored questionnaire – our tailored questionnaire focuses our inquiries to areas that cannot be assured through data and to specific tax risks such as propagation, investments in offshore limited partnerships and structured arrangements that provide additional imputation benefits. Refer to Taxation of investments
Following a review we share our findings with each fund, including:
- identifying areas where we have assurance that a fund has reported the right amount of income tax; and
- any identified concerns or tax risks.
We may recommend specific actions to obtain greater assurance in particular areas, and may follow up on these recommendations. If we identify concerns or areas of tax risk, we will engage with funds through a variety of tailored approaches. We will seek to work collaboratively with funds to obtain greater assurance or address identified concerns or tax risks. There will be circumstances where we will move to more intensive approaches, such as audits.
The outcomes of these reviews will help inform our engagement with funds over the next 12 months and include:
- working collaboratively with industry on areas such as tax governance to obtain higher levels of assurance; and
- engaging with funds on aspects where we have identified concerns or specific tax risks.
We will also consider whether some of these aspects require further public guidance to provide greater certainty and make it easier for funds to comply with their tax obligations.
Tax governance and third party data
Tax risk is the risk that funds may be paying or accounting for an incorrect amount of tax, or that the tax positions that a fund adopts are out of step with the tax risk appetite that the trustee board has authorised or believe is prudent. Because tax will ultimately impact upon member balances, funds have an obligation to ensure that they manage tax risk through a strong tax governance framework.
The ATO published an updated Tax risk management and governance review guide on 27 January 2017. The guide sets out principles for board-level and managerial-level responsibilities, with examples of evidence that demonstrates the design and operational effectiveness of tax control frameworks.
In addition to the controls set out in the ATO Guide, we have broadened our focus on tax governance for large superannuation funds to include controls relating to the quality and integrity of third party data which is key to the accurate reporting by funds in their income tax return.
For most funds, this starts with their custodian and obtaining a level of confidence that the data flowing through to and from a custodian is accurate. This also extends to the direct receipt of investment information from both domestic and foreign sources.
The appropriateness of the controls and processes will vary depending on the size of the fund and the complexity of the investments held. However, some fundamental controls trustees should consider include:
- Whether tax policies are prepared in accordance with the tax law. For example:
- Review of the custodian’s tax policy and processes to review and update in event of law change.
- Process to ensure instructions accord with the tax law where there is an override to a default position in the custodian’s tax policy e.g. external advice or a private binding ruling is sought.
- What steps a fund undertakes to be sufficiently satisfied that the returns and tax outcomes of investments are properly reflected in their tax return. For example:
- Review and testing of the information in trust distribution statements.
- Tax due diligence process for new investments.
- Processes and controls to identify and manage the Australian tax consequences of foreign investments.
- What assurance the fund seeks in relation to the accuracy of the data received and processed by service providers. For example:
- Employment of independent assurance providers (internal or external) on the effectiveness of the tax controls of service providers and the accuracy of the data they receive and process, e.g. trust distribution statements.
Given the reliance funds have on the data provided by third parties in completing their income tax return, strong governance over this data is an important factor we take into account in determining the level of assurance obtained over particular aspects of the fund’s economic activity in our reviews.
This includes whether the amount of investment income derived from investments such as offshore limited partnerships or managed investment trusts has been correctly reported as well as the claiming of associated offsets and deductions. In circumstances where a fund cannot demonstrate good governance over third party data, we are unable to gain high assurance for these aspects.
Useful insights on findings on tax governance and ratings provided to date through the general Top 1000 Program can be found in our latest Findings Report Top 1000 Tax Performance Program
We seek to apply a consistent rating system when reviewing and assessing tax governance of funds (further guidance on the rating system is available in the latest findings report). However, in recognition of the broadened scope of governance to include controls over third party data, we have assessed some funds as Provisional Stage 2. This provisional rating acknowledges that some funds have reached Stage 2 for their overall tax governance framework when assessed against the ATO Guide, however were assessed at Stage 1 for governance over third party data.
From our limited engagement with funds to date, common reasons for funds achieving Stage 1 rating for their tax governance include:
- A narrative description of the tax control framework is not evidence that can be relied upon. Processes should be documented rather than a narrative being provided.
- No gap analysis was provided or gap analysis was provided with no document references to support how controls are aligned with the ATO Guide.
- Limited evidence of controls and processes over third party data.
We will continue to engage with funds through the Justified Trust Program to gain insights on the necessary controls and processes over third party data. We will use this intelligence and consult further with industry to provide guidance on what is considered to be best practice for funds in this area.
As the funds under management continue to grow in this sector, we see funds seeking alternative investments through more complex arrangements, often to seek exposure to offshore investments. Funds are reminded that they need to have processes in place to manage the tax consequences of these arrangements to reduce the risk of non-compliance with their Australian tax obligations.
Through our engagement with funds over the last 12 months, we have expressed concerns over a number of domestic and offshore investment arrangements where we have identified specific tax risks. We are therefore likely to continue our engagement with funds on the following arrangements.
Structured arrangements and equity derivatives that provide imputation benefits
In February 2018, we published Taxpayer Alert TA 2018/1 on structured arrangements that provide imputation benefits on shares acquired on a limited risk basis around ex-dividend dates after becoming aware of certain arrangements being entered into by entities including superannuation funds.
We have also become aware of similar arrangements not covered by TA 2018/1 including those involving the use of derivative instruments, where it is clear that additional imputation benefits are being sought.
We are not concerned with the use of derivative instruments as part of a fund’s investment strategy recognising that there may be clear commercial reasons why funds seek to utilise such instruments.
However, where funds utilise such arrangements to obtain additional imputation credits, we will consider the following:
- Whether a participant is a qualified person as per Division 1A of former Part III of the Income Tax Assessment Act 1936 (ITAA 1936), particularly where arrangements are put in place to substantially reduce their risk of loss or economic benefit of the underlying Australian equities.
- Whether it is appropriate to make a determination under section 276-90 of the Income Tax Assessment Act 1997 (ITAA 1997) where a participant invests in Australian equities via an AMIT (Attribution Managed Investment Trust) and enters into an arrangement that directly or indirectly reduces the economic exposure to changes in the value of the membership interests held in the AMIT.
- Where a fund has put in place a structured arrangement seeking a franking credit benefit, whether section 177EA of the ITAA 1936 should apply.
We will continue to engage with funds to gain a better understanding of arrangements that involve holding an additional long position in Australian equities, whether directly, or indirectly, and entering into related derivative instruments that reduce economic exposure to the returns and capital performance of those equities. These derivative instruments can include, but are not limited to, Total Return Swaps and short positions on futures contracts.
In our Top 1000 reviews, we will query funds on whether they have entered into these types of arrangements. Where we observe that a fund has entered into these or similar arrangements, we are likely to undertake more intensive engagement.
We will also consider whether further public guidance is warranted. Funds or advisers contemplating these arrangements are encouraged to speak to us prior to implementing the arrangement.
Foreign income tax offsets (FITO) and foreign exchange (FX) gains and losses
The ATO has previously engaged with funds on compliance matters associated with the Commissioner’s view contained in TR 2014/7 and how funds treat FX hedging gains and losses in respect of the calculation of the FITO limit.
We have also issued Practical Compliance Guideline PCG 2016/6 that sets out the ATO’s compliance approach to taxpayers determining the source of certain hedging gains for the purposes of calculating the FITO limit.
In our engagement with funds through our Justified Trust Program, we continue to seek assurance that funds are complying with the views in TR 2014/7 and in particular determining which FX gains are foreign sourced, which portfolios those FX gains relate to and which reasonably related deductions relate to those FX gains.
We also seek to gain an understanding as to whether funds have opted to apply PCG 2016/6 which is based on applying a reasonable approach to determining source of FX gains taking into account relevant matters. Our early observations include that the following relevant matters have not been taken into account by funds:
- Either a single branch or multi branch ISDA did not include an Australian branch;
- The branches identified in the SWIFT 300 confirmations were offshore;
- The presence of an Australian branch for a foreign bank counterparty is not enough to classify a FX hedging gain as being domestic sourced even if is undertaken in Australian business hours if that branch does not actually conduct its FX trades in Australia. Further information may be required from the hedge manager and/or foreign banks to confirm whether they actually trade in Australia;
- Initial contact may occur with a dealer in Australia, but the forward points for a forward FX contract are agreed later, meaning that the contract is formed in another jurisdiction (may be foreign or domestic); and
- Multiple trades with identical time stamps which cause us concern as to the reliability of the information provided by the hedge manager to the superannuation fund.
We anticipate that large superannuation funds are likely to incur net FX losses in the 2019 income year which may have a significant impact on the FITOs claimed for this year. We are therefore likely to continue our engagement with funds to ensure compliance with the views contained in TR 2014/7 and PCG 2016/6.
Corporate limited partnerships (CLPs)
Given the investments by funds through CLPs has increased over recent years, we are seeking to understand the characterisation of the distributions from these investments. We have observed some instances where information provided to the fund (and custodian) report that distributions received from CLPs are treated for Australian tax purposes as either 100% return of capital or 100% assessable dividends.
We are concerned that this does not accurately reflect the economic substance of the fund’s investment in the CLP or the economic activities of the CLP. Where the characterisation of the distributions is not accurately reflected, this will most likely result in incorrect tax treatment being applied by the fund.
We acknowledge industry feedback on this issue to date regarding the limitations funds may face in obtaining relevant tax information. However, we expect funds to have sufficient controls and processes in place to review these distributions and ensure they are accurately brought to account for Australian tax purposes. This may include requesting further information from the CLP or utilising other sources of information relating to the performance of, or the underlying transactions of the CLP.
We will continue to work with industry and individual funds to gain insights on industry practice with respect to these investments and consider whether further engagement or public advice is warranted.
Other foreign investments
As previously noted, with more funds seeking exposure to foreign investments as part of their investment strategies, we are paying particular attention to the characteristics of these investments and returns for Australian tax purposes including:
- The treatment of gains as revenue or capital from disposals of investments by a foreign hybrid limited partnership in which a fund holds an interest.
- Whether the fund employs adequate controls to identify relevant interests in a controlled foreign company and ensure the correct calculation of attributable income.
- The appropriateness of ‘bed and breakfast’ arrangements particularly where the practice is undertaken because of an inability to accurately calculate the attributable income.
Advice and guidance
Where appropriate, we will continue to provide industry with certainty on how the tax law applies to their circumstances through advice and guidance. While we provide a tailored advice and guidance service on a one on one basis such as our early engagement process, we have continued to provide industry with certainty through public advice and guidance on the following aspects.
Pension tax bonus
On 17 July 2019, we published draft practical compliance guideline PCG 2019/D2 that outlines our compliance approach for large superannuation funds in respect of pension tax bonuses. It provides our transitional compliance approach where funds are having practical difficulties in complying with certain legislative requirements, specifically where IT systems may not correctly reflect the pension tax bonus in the members’ opening account balances.
The PCG outlines conditions where we would not allocate compliance resources to review the calculation of exempt current pension income as a result of a fund not incorporating the value of the pension tax bonus for the purpose of calculating required minimum pension payment amounts.
We therefore expect that our compliance approach will only impact the calculation of required minimum pension payments made in the year that the relevant superannuation income stream commences. This is dependent on all the conditions outlined in the PCG being met including the requirement for funds to update their IT systems by 30 June 2020.
Consultation closed on 14 August 2019. We are now considering feedback and will issue a final PCG shortly. Funds that do not meet the conditions in the draft PCG are encouraged to speak to us prior to implementing the arrangement.
Royal commission – web guidance
The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry has now concluded. With attention turning to the tax consequences of remediation and compensation payments, we have been working to provide certainty to a range of stakeholders.
In October 2018, we published advice on the tax consequences for compensation paid directly to individuals. See Compensation paid to individuals for advice from financial institutions
If a superannuation fund receives compensation, the trustee will need to be aware of possible super, income tax and goods and services tax (GST) consequences. These consequences will depend on the specific facts and circumstances the compensation amounts relate to, and how they are received.
Compensation received by super funds
In July 2019, we published web guidance on the income tax, GST and superannuation consequences for compensation payments by financial service providers to superannuation funds. See Compensation received by super funds from financial institutions and insurance providers
This latest guidance provides our views on payments that have been made as compensation for:
- Fees where no service is provided.
- Deficient financial advice.
- Overcharged insurance premiums.
Several aspects of the guidance, and the process of its development, are considered here.
Relationship to past advice
While the guidance is new in that it sets out broad principles to be applied by funds and other relevant entities in some particular scenarios, those principles reflect our existing published views including:
- Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts
- Taxation Ruling TR 2010/1 Income tax: superannuation contributions
- Goods and Services Tax Ruling GSTR 2001/4 Goods and Services Tax: GST consequences of court orders and out-of-court settlements
These documents remain a central point of reference for the Commissioner’s views on those particular topics and the web guidance should be read within that context.
Scope of web guidance
In order to determine what we believe to be an appropriate scope for the published material, we consulted with key stakeholders including industry representatives, advisers, funds, regulators, and the Australian Financial Complaints Authority.
We structured the advice on principles because we acknowledge that the guidance will not exhaustively cover all possible permutations, but expect that reading the guidance together with our other published advice; it will cover the majority of scenarios.
While our guidance does not comment on the suitability or appropriateness of compensation that may be agreed between parties (being a matter for the co-regulators ASIC and APRA), it does highlight the potential tax and super consequences of remediation programs that may take place.
A key concern for all stakeholders is certainty on the Commissioner’s views as to when compensation payments will be contributions. This is a notable concern given the potential for members to unintentionally exceed their contribution caps.
Characterisation of an amount as a contribution will depend on:
- the nature of the payment,
- who may have the legal right to the compensation,
- whether the payment made to a fund increases or augments the capital of the fund; and
- whether special rules concerning payments made out of reserves held by the fund apply.
When a payment is not a contribution
We identified that when a payment is paid to a fund trustee that has a right to that compensation, then the payment would be in satisfaction of a right held by the fund trustee that already forms part of the capital of the fund and therefore, not a contribution. This basic principle is also reflected throughout the guidance.
Whether a fund trustee has a right to compensation will depend on:
- the terms of the arrangement for the original transaction,
- the specifics of the claim and settlement; and
- the form of compensation being proposed.
When a payment is a contribution
Where a fund trustee does not have the right to compensation, then any compensation paid will generally be an increase in the capital of the fund and therefore a contribution. For example, where:
- the right to compensation belongs to the member personally rather than to the fund trustee, a payment to the fund would result in the payment being a contribution,
- a payment is made to the fund for which the fund does not have a right to (for example, in respect of members who may have received advice), then the amount allocated to that member would be also treated as a contribution for that member.
Income tax considerations
The income tax consequences of funds receiving compensation payments are also explained in detail in the guidance, and are separately detailed for payments that have been received as compensation for:
- Fees where no service is provided.
- Deficient financial advice.
- Overcharged insurance premiums.
Broadly speaking, in the scenarios considered, compensation amounts in relation to lost value, or lost earnings or interest, are subject to the capital gains tax (CGT) provisions. This is because the receipt of compensation involves a CGT event happening to a CGT asset of the fund. The exact treatment under the CGT provisions depends on a range of factors outlined in the guidance, including whether the relevant asset is an investment or the right to compensation itself.
There are some practical issues to be considered regarding the GST implications of compensation payments referred to in our guidance. A superannuation fund trustee will need to consider whether it is required to repay the GST credits claimed where it receives a compensation amount that reflects a refund of fees paid to a financial service provider, and the superannuation fund had previously claimed GST credits or reduced GST credits on the fees.
The financial services provider will also need to consider their situation in respect of making the compensation payment to the superannuation fund.
Law reform and implementation
Law reform and implementation continues to be a focus for the ATO and large superannuation funds. Included in the 2019–20 Budget, was the measure to make permanent the current tax relief for merging superannuation funds that is due to expire on 1 July 2020. Other measures affecting large superannuation funds include:
- Protecting Your Superannuation Package – this package of reforms announced in the 2018–19 Budget and has now been passed by Parliament. The law introduces a number of initiatives to protect individuals’ retirement savings. Amongst other measures, we will now be able to proactively consolidate certain types of unclaimed super money to an eligible active super account via an ATO-initiated transfer. For further information see Protecting your super package
- Non-arm’s length income – The Treasury Laws Amendment (2018 Superannuation Measures No. 1) Bill 2019 that was recently introduced, contains amendments to remove any ambiguity about how the non-arm’s length income provisions apply to income derived from schemes where the superannuation entity has incurred non-arm’s length expenditure. We do not expect these amendments to have any significant effects on large superannuation funds. We are working to publish a new Law Companion Ruling (LCR). The new LCR will incorporate the feedback received in relation to the withdrawn LCR 2018/D10.
To keep up to date on these and other anticipated measures funds are encouraged to:
- See all our current news for APRA-regulated funds and current Super CRT Alerts.
- Subscribe to email updates to see when we update our news pages.
- Subscribe to Super News for a monthly wrap-up of news and updates.
Over the next 12 months, the ATO will continue to build upon our strong and collaborative relationship with industry.
We will continue to provide assurance to the community and government that funds are meeting their obligations through our Justified Trust Program, affording us the opportunity to gain a holistic understanding of the industry and its operation. As we continue to progress through the program, we will share our findings and insights to help funds make improvements and focus their activities over the next 12 months.
We expect the outcomes of these reviews to shape the design of our future engagement with the industry and individual funds to target high risk areas as well as providing support and certainty to industry on aspects of their operation that will continue to evolve such as tax governanc