An Australian Financial Complaints Authority (AFCA) determination handed down last year has the potential to severely and adversely impact a large number of SMSF trustees. Basically, the complaints body ruled an SMSF trustee cannot be considered a wholesale or sophisticated investor if they don’t meet the condition of controlling gross assets of at least $10 million as stipulated in the Corporations Act 2001.
This decision doesn’t appear too egregious on the surface, but this is the most arduous test contained in the legislation and one many SMSF trustees who have been operating as sophisticated or wholesale investors cannot satisfy.
How can this be the case then? Well, these SMSF trustees did satisfy the lower legal threshold that allowed them to be considered wholesale or sophisticated investors, that being, they had a certificate issued by a qualified accountant saying they, as an individual, have net assets of at least $2.5 million.
As you can see, these two approaches are incompatible so how could AFCA make a ruling like this? Well, section 761G(6)(b) of the act says if a financial service provided relates to a superannuation fund, then the individual involved must be considered to be a retail investor and to be treated as a wholesale investor must satisfy the $10 million gross asset threshold.
Well that seems pretty clear cut, doesn’t it? Not really due to the role the Australian Securities and Investments Commission (ASIC) has played in this situation. Back in 2014, it acknowledged there was confusion around these rules, but took a pragmatic approach towards enforcing them. Basically, the corporate regulator said the $10 million test should strictly speaking apply to SMSFs, but assured individuals it would not take any action against them if they had relied on the $2.5 million threshold to be considered a wholesale investor. Subsequently, it has been accepted practice in the SMSF sector for trustees to be treated as wholesale investors if they could meet this less severe test.
The AFCA determination now puts all of the trustees who have relied on the $2.5 million net asset test in danger, particularly if they do not have the asset backing to meet the $10 million parameter. Worst-case scenario it will mean they have invested in products illegally and as a result will likely have to relinquish their holdings in these offerings.
If forced to do this, these trustees will be facing significant capital gains tax liabilities due to the fact wholesale products by nature require larger minimum investment amounts – the disparity of which could be the difference between a $200,000 commitment on a wholesale level and a $5000 commitment on a retail scale.
So where do we go from here? While the argument can be made the rules are the rules and there is no excuse for bending them a little, even the toughest critic would have to admit punishing trustees who have used the lower threshold on the back of ASIC’s communicated softer enforcement approach would be very harsh.
The good news is the SMSF Association is already on the case and has begun lobbying for a legislative fix stipulating trustees can be treated as a wholesale or sophisticated investor if they satisfy the $2.5 million net asset test, but who knows how this will ultimately land.
As they say in the classics, watch this space.
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