But what are these accounts and do they represent reserves?
Over the past several years the ATO has released multiple interpretative decisions, tax determinations and public statements that confirm the use of contribution reserving strategies in SMSFs. However, when using this strategy, a question arises as to the status of the contributed amount between the time of contribution and allocation: Is it a reserve or some other type of unallocated account?
This is important as where the amount is considered a reserve, a trustee will need to ensure the governing rules of the fund do not prohibit the trustee from maintaining reserves. In addition, the trustee will have an obligation to formulate, regularly review and implement a strategy for the reserve in accordance with the superannuation covenants in section 52B of the Superannuation Industry Supervision Act 1993 (SIS Act).
Contribution reserving strategies involve a trustee allocating contributions received for a member to a reserve or other unallocated contribution account prior to allocating them to the member’s account within:
- 28 days after the end of the month in which the contribution was made, or
- within a longer period as is reasonable in the circumstances.
In this situation, the ATO has confirmed that where a contribution is made in June of one financial year (Year 1) but not allocated to the member until the next financial year (Year 2), the contribution counts towards the member’s concessional cap in the year it is allocated (Year 2). In addition, the ATO also confirmed that where the contribution is a personal tax deductible contribution, the contribution is deductible to the member in Year 1.
In this situation, a question arises as to the status of the contributed amount pending allocation. The ATO interpretative decisions and tax determinations on this issue refer to contributions being allocated to an ‘unallocated contribution account’. But what are these accounts and do they represent reserves?
What are reserves?
Unfortunately, the meaning of reserves is not defined in the SIS Act. However, the ATO defined the meaning of a reserve in ATO Interpretative Decision 2015–213 as: ‘An amount set aside from the amounts allocated to particular members to be used for a certain purpose or on the happening of a certain event’.
In addition, the APRA published Prudential Practice Guide SPG 222 – Management of Reserves, which defines reserves as: ‘Monies forming part of the net assets of a registrable superannuation entity (RSE) that have been set aside for a clearly stated purpose’.
Both these definitions imply that reserves are amounts that have been set aside for a future purpose or as a contingency for future events rather than as a means of accounting for past events.
This is supported by SPG 222, which confirms that not all unallocated monies constitute reserves and that unallocated monies that are not reserves include:
- accrued expenses
- provisions for tax and administration liabilities
- accounting constructs, such as suspense accounts, used to record contributions pending their allocation to specific member accounts.
Finally, the wording from the Explanatory Statement (ES)4 to the SIS regulation that introduced the requirement for contributions to be allocated within a specified period also supports the notion that accounting constructs, such as unallocated contribution accounts, are not reserves for superannuation purposes. For example, the ES suggests that the amendments were intended to prevent members avoiding the superannuation surcharge by allocating contributions to reserves or through the use of other types of arrangements that don’t involve reserves, such as by deferring the allocation of contributions.
Therefore, it appears that unallocated contribution accounts that are used to account for contributions pending their deferred allocation may not be reserves for superannuation purposes. However, in the absence of any specific clarification from the ATO or the courts in regard to this issue, trustees may also need to be mindful of their fund’s own governing rules.
For example, many SMSF trust deeds often contain specific provisions that give trustees the power to establish and maintain ‘contributions reserves’ to ensure members can implement a contribution reserving strategy. In this case, if the fund’s own governing rules clarify the issue by defining these amounts as ‘reserves’, it would be prudent to treat these amounts as reserves for superannuation purposes.
Why is it important?
Under the SIS covenants where a fund has reserves the trustee is required to formulate, review regularly and give effect to a strategy for the prudential management of the reserves that is consistent with the fund’s investment strategy and that takes into account the fund’s capacity to discharge its liabilities (actual and contingent) when they are due.
While the ATO as regulator of SMSFs has not provided any clarification on what it expects to be included in a reserve strategy, APRA SPG 222 provides some useful guidance on what a reserve strategy should cover, including:
- the purposes of the reserve
- the appropriate size for the reserve given its purpose
- how the reserve is to be funded or built up
- when amounts can be allocated to and from the reserve and
- how the reserve should be would up when it’s no longer required.
Therefore, where a fund’s governing rules allow for the use of contribution reserves, the trustees may wish to consider formulating a reserve strategy to ensure compliance with their statutory obligations.
In this case, the reserve strategy could specify that given the short-term nature of the reserve it will be invested in bank deposits in accordance with the cash allocation as specified in the fund’s investment strategy.
While an unallocated contribution account may not constitute a reserve for superannuation purposes, trustees need to take care to consider the wording of the fund’s trust deed. Where an SMSF’s deed defines these amounts as reserves; the trustees should consider formulating a reserve strategy to ensure compliance with their statutory obligations.
Columnist: Craig Day
Wednesday 10 February 2016