Martin: Welcome to The Business Owners Podcast where we throw aside taboos and share strategies for growing, protecting and exiting your business. My name is Martin Checketts and I represent Mills Oakley’s Private Advisory team.
Hello everybody! Welcome back to Season on Tax issues for business owners. I’m delight again to be joined by my colleague Ross Higgins. Welcome Ross!
Ross: Good morning, Martin.
Martin: So Ross is a partner in Mills Oakley’s Private Advisory team, he has had a 30 year career specialising in tax and he is dual qualified as a lawyer and an accountant. And on a personal level I very much enjoy working with Ross around thorny tax issues for business owners.
So in this episode Ross is going to be talking to us about superannuation. And in my experience this is an area that is just not well understood at all by business owners. And particularly not in relation to some of the opportunities that exist for them through investing in super. So it might not sound as sexy as investing in a new business, but when you hear what Ross’s got to say we are hoping today to change your mind. So Ross, why is super sexy?
Ross: Well, it’s all about balancing things between “for now” and “for future”. Some business owners in a sense put all their eggs in one basket and sometimes don’t pay themselves salaries, don’t pay money in super, treat their business as their superannuation. Of course that works when everything goes well, but if things don’t go well than it could mean if your business goes down and you’ve got no super, you haven’t really progressed very far. So I tend to say to people that it’s a matter of not putting all your eggs in one basket, try to put some of your eggs, your golden eggs, into super. So that you have got a look to the future as well as what you are doing in your business. And the beauty of super is that money that you put into the super fund is protected absolutely from bankruptcy unless at the time you put it in there you knew that you are going insolvent and you were doing it to avoid your creditors. It’s pretty rock solid protection against bankruptcy. And it is better to have a certain amount of money going regularly into super, you know people talk about dollar cost averaging and just that constant putting money in over time is the best way to build. And on the other hand if you can borrow a certain amount of money in your business, then you have got money for business rather than funding it yourself and you get tax deductions for the interest and you are hedging your bets between the value of your business and making sure you have got some money in super for the future.
Martin: That’s great Ross, and I was just thinking of a number of business owner clients that I work with, as you were saying that. And once they are in that position of having superannuated themselves along the way and built assets outside their business, they really are in so much of a better position as they hit their 60s and 70s. And I see this because I work with them every day and chair their advisory boards, you know the pressure is really off. And of course you want to make some value out of your business, of course you want to sell it for squillion dollars, but if you know that you have salted it away enough in the background so that you are always going to be comfortable in retirement, that’s just an amazingly comfortable and comforting position to be in, as somebody who takes business risks day and day out. What a double benefit that as you say it’s not only a tax effective way to save for your retirement but it’s insulated, right? It’s completely insulated against business risks.
Ross: And one of the key things is that if an individual borrows some money to put into super, there is a specific prohibition on getting a tax deduction. Whereas when a business borrows to put money into super, they get a tax deduction for the interest. I’d also say that in the early times of when you are putting money in super, the money in super is not going to be great initially, so the most important thing in the earlier years of super, particularly if you have a spouse, particularly if you have children, is to take out life insurance. Because if you die, and you have got $10,000 in your super, that’s not going to help your family very much. But if you have got $5,000 in super and you’ve got a quarter of a million dollar life insurance policy benefit, than you are in a much better position. So during the early times of creating your super fund, the key thing to protect you is to take out good life insurance.
Martin: And I don’t want to get too technical, because I know this is a complex area, but there are some good tax benefits around getting insurance through super, yes?
Ross: Yes, look, you have a choice whether you claim the deduction for the premium or not. Some people are keen, because they can get a deduction for the life insurance premium. Whereas if you take it out personally you do not get a tax deduction for the premium. Basically what a premium does is wipes out the contributions tax on the way into the super fund. On downside of that, however, is that you get taxed a bit more highly when you get the benefit if you die, and the fund gets a benefit from the life policy, the tax treatment of that is not quite as valuable. So some people, including myself, I might say I don’t take deduction for the premium for the policy on the basis that if something happened to me, my benefit would come in and would remain untaxed. And more money would end up in the pocket of my family. But it is a choice. You can do your own numbers; you can make your own decisions as to which way you go.
Martin: Thank you. And of course if you get the insurance through the super fund, and of course you have got to pay for it, it’s just in a different pot. But some people like that too, don’t they? And they don’t have to find a cash flow to pay for the insurance, as they have got superannuation and they can fund the insurance out of that “pot” if you like.
Ross: Yes, and also that insurance is protected from bankruptcy, and you can have, for example if you died, generally you would want some sort of pension to go to your spouse or partner. And that would include, of course, the value of that superannuation benefit, which came in.
Martin: So if you died hopelessly bankrupt owing millions of dollars, you are saying that the procedure of your life insurance policy would not be exposed to your creditors?
Ross: That’s right. It’s in a super fund. And the pension could go to the spouse, again assuming that spouse that your spouse was not subject to bankruptcy. Even if they were, if they’ve just taken the pension and that pension took them up of what was allowed under the bankruptcy rules, then the principle would remain in the super fund. If they were getting a high pension, well it might mean just a little bit of that pension might end up in creditors’ hands. But basically your capital would be protected.
Martin: That’s fascinating, Ross. And you are certainly shifting my headspace as we speak about this. Super is well known as a tax effective structure for retirement, but yes, what a wonderful double benefit it is: the tax and, for business owners in particular, it’s the asset protection.
Now, a lot of business owners get to a certain amount in a super fund, and they think about setting up a SMSF. Could you talk to us about that?
Ross: Well, when you set up a SMSF, you have a greater control over your investments. And then as a director of the SMSF trustee, where the trustee to understand the super rules, make sure you comply with the prudential requirements, but you do have more control over your choice of investments properly made. And a lot of people like that.
Martin: Can I just jump in there Ross, because that sounds scary. You know, people listening to you talking about prudential requirements and almost having to take on the responsibilities of an investment manager, if you like, with all of the accountabilities that go with that. But that’s actually not overstating it, is it? This is the duty of the trustee of a superannuation fund.
Ross: Yes, well you have to take it very seriously. In fact when you become director or a trustee, you have to sign a declaration which has detailed content, and that’s required under the superannuation law. And this detailed guidance is issued by the tax office in relation to those responsibilities. Now, of course, that doesn’t mean that you have to make all the decisions by yourself, usually if somebody has an SMSF, they also have a financial adviser on side. And in fact if you are a busy person and you have not got time to pay regular attention to your investments that in many cases you should invest in various managed funds anyway and that financial adviser will help you select a portfolio of managed funds according to your risk profile. And risk profile might depend on you personally and your other assets, and also your age, and your income – also lots of factors to decide whether you are a “balance fund” type person or whether you are more of a “growth phase” type person or whether you are at that stage, being much more conservative in what sorts of investments you have. And other people on another hand will say, no I’m going to buy a property and I’m going to have a bit of portfolio of shares and the rest I’m going to have in a bank at as good interest rate as I can and I’m happy to manage it myself.
Martin: So Ross, I like start-ups, you know tech start-ups. And I think I could put in some money and maybe get 20 times return if things go well. So I mean I could just take my SMSF money and put it into start-ups. Would you recommend that? Can that fit with my risk profile?
Ross: Well, I haven’t got a financial services license, Martin, but..
Martin: (laughing) thanks for confirming this… making sure that Mills Oakley PI policy is fully protected… I am grateful!
Ross: Yes, yes. Look you’ve got to be very careful about what you are investing in; I have seen some people get up their superannuation to incredible heights with many, many millions in there through a good investment. I’ve also seen some people who haven’t done the right thing, who have lent to parties that they know, that have convinced them that “this is a good investment by lending to my entity/ investing in my entity”, and they’ve blown it all. It’s like any other investment, you’ve got to be careful, you should have an independent adviser, you should balance out your investments and if you take a sensible approach to it and you take advice then superannuation savings should be built nicely for you. And important thing to know is that superannuation is not an investment, it’s just an investment vehicle. So what you do inside that vehicle has certain restrictions and prudential requirements around it. But invest badly and stupidly and no in accordance with the rules and blow it all, it’s your fault.
Martin: Love it, thank you! Let’s talk, Ross, about in-house assets. Because there is a bunch of rules as I understand it that was stop you, as a business owner for example, from owning all of the shares in your company through your superannuation fund. And these rules are not well understood. Could you give us an overview of those aspects?
Ross: Yes, the “your house asset” rule, we’ve brought it many years ago, and basically what was happening with a lot of businesses is that they were contributing money into super and then lending it straight out back to the business. And by lending it out back to the business, of course, it was subjecting it to the business risk. And from our policy point of view the government thought “Well, this is not really a good thing, we want super to be building up towards people’s retirement. If the business goes down and drags down the super fund with it, then we haven’t really achieved the objective that super is meant to achieve”. And so they introduced the in-house asset rule in 1999, and basically said “Well, look, we will allow you to have up to 5% of the market value of the fund in in-house assets, we will allow a bit of slippage, but basically beyond that you are not meant to have in-house assets”.
Now, in-house assets are investments back into a related party, like the employer company, or even a related entity, like a family trust or company. And so it can be by way of equity into units or shares into related party, or it can be a loan into related party and it also covers leasing or similar arrangements from the fund back to the business. There are some key exceptions, and the most notable one, which a lot of businesses utilise, is business real property that you can actually have a superannuation fund that holds commercial property, which can be used in someone’s business and that someone can also be a related party, it can be effectively your business entity that is carrying on the business in the premises own by the super fund. That is fantastic for a lot of business owners, because that goes hand in hand with that asset protection type approach “Great, I will put money in my super fund, I wouldn’t want the property in the same entity as my business anyway, but rather than put it, say, in discretionary trust, I can put into a super fund instead of paying high level of land tax based on surcharge rates into discretionary trust, I only pay ordinary land tax rates in a super fund, I also get the benefit of low tax rates at 15% in a super fund on income, and ultimately if I sell the property and I am still not in pension phase, I get a discount and pay only 10% on a capital gain.” It’s just a fantastic environment. So you protect your business property, at the same time still being able to use your own funds to effectively do that.
Martin: Wow! It just sounds so compelling when you say it in that way, Ross. Talk to us some borrowing in the super fund, borrowing to buy a property.
Ross: Look, the borrowing rules were introduced back in I think 2007, and then modified later in 2010. And essentially you must start off from the position that there is a general prohibition on borrowing in super funds, you can’t borrow. And there are some minor exemptions for temporary borrowing for paying benefits but then you suppose to pay back very shortly, but a major exemption is for a complying borrowing, they are often called “limited recourse borrowing arrangements”. And the requirement is prescribed by the superannuation law, and it’s important that you understand how that works because you must know how it works before you buy.
Somebody came to me once, bought a piece of land, and then they said “oh, I’ve heard about borrowing in super, can I borrow to build on it?”, and the rules don’t allow you to do that. So therefore they had to sell the property. So you have to get advice first, right? Property is very lumpy, if you want to borrow and use the borrowing rules, a key thing is you have to actually buy the property not in the super fund, but it has to be held by a custodian trustee, what is also called a bare trustee, or a nominee trustee. And this is separate to a trustee of a super fund. Super fund holds it 100% beneficially but legally it’s got to be held in a name of this nominee. Then the borrowing arrangement has to be such that, if there is default and a lender can take recourse, the lender’s recourse must be limited to the property itself and no other assets of the super fund. Policy makers decided that if they are going to allow these arrangements then it had to be the case, they did not want to see people’s whole superannuation benefits being put at risk by borrowing arrangements. So the recourse has to be limited to the property itself. So that often means that many lenders might lend up to 60-70%, maybe 75%, but not say 80% or beyond in relation to such arrangements, because they have recourse only to the property. But these arrangements can be a great way to effectively turbocharge in a sense the growth of your fund, particularly when concessional deductable contributions are actually going down and they are limited; if you have a borrowing arrangement it’s like borrowing arrangements outside super. It effectively is a way to leverage using other people’s money and grow your pool of assets.
Martin: Okay, so that’s… I am just trying to assimilate all of that. And yes, I have now realised exactly why the banks are so conservative when it comes to borrowing in super. But boy! If you could do it with all of those benefits, it’s starting to sound pretty attractive. I mean of course there is always a question of your asset allocation that you have mentioned at the beginning and the right thing as a trustee and a director of a super fund to expose all of the asset to Australian real property, for example. So I guess there is kind of some proportionality there..
Ross: And it’s nice to have other assets, because the bank will look at it as well and they always look at the serviceability. So even if they have recourse to the asset, they will be looking at what assets the super fund has and what are the income returns that will enable it to service the loan. I have mentioned before about someone buying a property and then having to sell it. One of the key things is that if you do a borrowing arrangement, it has to be in relation to purchase of a single acquirable asset, so-called. So that means that if you buy a block of land, and then you think “well, I will borrow to build on it” as you might literally do outside super, you can’t do that because the borrowing has to be in relation to acquiring the land. So if you wanted to buy, you can buy an off the plan purchase, right? So you use initially for the deposit non borrowed moneys, you enter into the contract. Once the land is complete with a building on it, could be a strata unit or something like that, then you can borrow. And at that stage the land and the building has been complete and it’s single acquirable asset, but if you buy the land separately, you can’t borrow to improve the land.
Martin: And here it comes back to this key point, doesn’t it? Just make a quick call to somebody like yourself before you do anything and yes, a lot of this is very complex. I am a lawyer and my head spins with it after a while, but thinking through that and just to the end point, the action point, very simple. Just don’t buy it before you have spoken with somebody, that’s the answer, isn’t it? It’s only a five minute call; that is all it takes.
Ross: Well, that’s right. So for example, if someone’s signed an off the plan purchase in relation to their super fund and have just put the name of the super fund, and then say: “oh maybe I want a borrowing”, so you say ”Ok, so we need to set up a nominee and we need to nominate that nominee” because it’s a nominee who has to be the owner of the property, not the super fund trustee. So you need to act quickly and fortunately under Victorian contracts, then you have this nominee clause and this ability to do that.
Martin: That’s great Ross, look we are at the end of time for our session today on superannuation, I’ve certainly learned enough a lot: I’ve learned about asset protection benefits of super for business owners, over and above the taxation benefits, and if you can use super cleverly those two things together, I think it’s a very powerful combination. I have also learnt about borrowing in super and how that can really help if you can structure it properly. And also of course about the duties of trustees of SMSF, it can be a great and flexible vehicle to use, but the level of responsibility that you have and the level of legal risk is certainly two or three notches above than putting it in a retail fund and I would very much echo Ross’s advice that you would want to have a good financial planner sitting there right alongside you to help in relation to the assets and the asset allocation for your self-managed super fund.
So thank you very much Ross, it’s been fascinating!
Ross: Thank you