Question: Did you receive a letter from the ATO about your SMSF investment strategy?

SMSF Trustees and ATO

Question: Did you receive a letter from the ATO about your SMSF investment strategy?

The Australian Taxation Office (ATO) has taken a keen interest in self-managed superannuation funds (SMSF) that hold most of their funds in a single asset (such as a property) or in a single asset class because they are concerned that the fund may not meet the diversification requirement of an investment strategy.

On this basis the ATO has begun issuing letters to relevant funds and their auditors reiterating the responsibility of the trustees to comply with regulations relating to investment strategies.

An investment strategy in its most simple definition is a document designed to outline what the trustees of the fund are trying to achieve (its objective) and how they have or will go about trying to get there. Regulation 4.09 of the Superannuation Industry (Supervision) Act 1993 (SIS) covers the elements that trustees are required to consider when preparing and reviewing the investment strategy:

  • The risk involved in making, holding and realising, and the likely return from the fund’s investments, having regard to its objectives and expected cash flow requirements;
  • The composition of the fund’s investments as a whole, including the extent to which they are diverse or involve exposure of the fund to risks from inadequate diversification;
  • The liquidity of the fund’s investments, having regard to its expected cash flow requirements;
  • The ability of the fund to discharge its existing and prospective liabilities; and
  • Whether the trustees of the fund should hold a contract of insurance that provides insurance cover for any of the members of the fund.

It is important to note that the legislation and regulations do not define what is an appropriate level of diversification is or which asset classes a fund should investment in nor does it give the power ATO define what is appropriate. The trustee is merely required to consider and explain why they are going with a particular strategy, noting its advantages, disadvantages, cash flow and the risk profile and goals of the members.

SMSF Trustee inspects paperwork

What does this mean for SMSF Trustees in practical terms?

Funds that pursue a single asset strategy should consider inserting a paragraph in the investment strategy dealing with this issue. It should outline the general rationale for pursuing this approach and the recognition of higher risk and volatility that typically affect growth assets like shares and property and how this will be compensated by the prospect of higher returns and growth in the longer term. It is recommended that any elaboration be as specific to the property as possible (such as market data specific to the area).

Further, additional consideration may be required where the trustees have entered into a Limited Recourse Borrowing Arrangement (LRBA) to ensure they have considered such events such as the loan defaulting and liquidity of the investment where the asset is negatively geared.

Finally, it is important to note that auditors are not charged with judging the suitability of an investment strategy or the investments therein. Their focus is on compliance with Regulation 4.09, ensuring that the elements referred to above have been properly considered, documented and reviewed.

If you would like to discuss this further, our team at Waterford Financial Services is available for any questions or queries.