In some circumstances, your SMSF reserve account may assist if there is the potential for contributions to exceed caps, but there are limitations and rules you need to be aware of.
Firstly you should be aware that under Section 52(2)(i), if there are any reserves accounts in the fund, the trustees must formulate, review regularly and give effect to a separate strategy (or multiple strategies for each reserve account) for their prudential management, consistent with the fund's investment strategies and its capacity to discharge its liabilities (whether actual or contingent) as and when they fall due.
Under what circumstances trustees can set up and use a reserve account?
Check your trust deed carefully to ensure you understand when and how a reserve account can be used. Trustees may set up a reserve account either to:
Ø stabilize the investment earnings of the fund according to the reserving investment policy of the fund;
Ø hold contributions received by the fund which are yet to be allocated to members;
Ø provide for contingent expenses, or tax to be paid to the regulator;
Ø fund a pension that is needed for solvency reasons as instructed by an actuary or as otherwise determined by the trustee;
Ø make any anti-detriment payment as per Section 295 -485 of the ITAA 1997 or
Ø any other reason.
What is a contribution reserve account?
If the net assets of your SMSF are greater in value than the combined value of its members' account balances, you have a reserve. It is an amount of money that has not yet been allocated to the account of a fund member.
A contribution reserve account is an account set up within your fund specifically to hold contributions not yet allocated to member accounts. This article looks in depth at the use of contribution reserves. It does not examine the other types of reserve account listed above.
Does my deed permit me to have a reserve account?
Not all trust deeds allow trustees to hold reserves in their fund. Section 115 of the SIS Act states you can only set up a reserve account if your trust deed expressly allows you to do so. In the case of SMSFs using the trust deed.com.au document, your deed permits you to set up a reserve account. To update your trust deed to our deed, click here to learn more.
When can funds be transferred in and out of a contribution reserve account?
Trustee may transfer amounts from the reserve account which the Trustee determines, to any members' accounts, on any basis the Trustee considers equitable with complete discretion.
However, the Trustee must consider members' concessional contribution cap limits before making any such transfer. It is also important to understand the power given to the trustee over any reserve account in the context of the trust deed's requirements in relation to the acceptance of contributions on behalf of members.
What happens if you breach the concessional contributions cap amount?
Trustees may accept contributions on behalf of a member and may credit contributions directly to a member's account or, in the interim, credit an income account or a reserve account of the fund, subject to superannuation law and specifically ATO ID 2012/16.
How does this work in relation to the receipt of contributions and the use of the reserve contributions account? If a Trustee receives a contribution in a month in relation to an accumulation interest of a member, the Trustee must allocate the contribution to the member of the fund within 28 days after the end of that month consistent with SISR 7.8(2) (a).
This is the clincher in terms of using your reserve account to prevent a member from going over their concessional contributions caps as per section 292-25 of the ITAA 1997. To remain consistent with this SIS Regulation, this strategy can only really work if the contributions that would cause a cap breach are received in June.
For instance, if a contribution is received in June that would potentially push a fund member over their contribution cap for that financial year, the Trustee has that discretion to hold that contribution in the fund's contribution reserve account until 28 days from June 30 (i.e. up until 28 July). They would then allocate the contribution to the member's account in the following financial year, which means the contribution would count towards their concessional cap for the next financial year and they would avoid breaching their cap.
However, if a member was in danger of exceeding contribution caps at any other time of the year, SISR 7.8, means the allocation to the member's account would still need to occur within the current financial year and a breach of the concessional contribution caps could not be avoided by holding money in the reserve contributions account for the maximum period allowed.
For the 2011-12 and 2012-13 financial years only, if you have exceeded your concessional (before tax) contributions cap by $10,000 or less, you may receive a once only offer to have the excess concessional (before tax) contributions refunded to you and assessed at your marginal tax rate, rather than pay excess contributions tax.
For contributions made from 1 July 2013 onwards, if you exceed the concessional contributions cap, any excess concessional contributions will be included in your assessable income for the corresponding year and taxed at your marginal tax rate. In addition, you will be liable for the excess concessional contributions charge from the start of the income year (1st July) @ 90 day bank bill rate + 3%.
What is the ATO's position on the use of contribution reserve accounts?
The ATO finally clarified its position in ATO ID 2012/16, Click here to read the full ATO's Interpretive Decision It confirms that when a contribution has been received in one financial year, and allocated in accordance with the SISR to the member in a subsequent financial year, it is counted as a concessional contribution in the subsequent financial year.
ATO ID 2012/16 also confirms that the tax deduction is available in the year the contribution is made and that the fund will need to pay contributions tax on the amount in the year it is made, not the subsequent year.
The ATO doesn't expressly say the contribution must be held in a contribution reserve account. Instead, it refers to amounts being held temporarily in a 'holding' or 'suspense' account. However, if your trust deed refers to the use of reserve accounts, you must adhere to the governing rules of the fund by using a contributions reserve account.
Can I use the account to assist with non-concessional contribution cap issues?
Most current discussions around the use of contribution reserve accounts revolve around their use to assist members to avoid breaching their concessional contribution caps. However, it is our understanding that the same use can be made of your reserve account to manage non-concessional contributions.
The wording of SISR 7.8 does not discriminate between concessional and non-concessional contributions. It simply states that member contributions held in the reserve account must be dispersed to a member's account 28 days from the end of the month in which the contribution was received.
This may be a particularly appealing strategy when the bring-forward provisions are used to make non-concessional contributions of $450,000 in the following year with this year's contribution.
For example, if two members of a fund who are under 50 years old had to purchase a business use property from a related entity, they could make cash non- concessional contribution in June of up to $600,000 each and purchase the property in June and allocate $150,000 in the current financial year and credit the remainder $450,000 to a reserve account to be allocated to the member accounts in the following financial year.
You could argue that the reason why concessional contributions need to be moved relatively quickly into a member's account is to ensure that member receives the tax deduction they are entitled to for making those contributions. However, no tax deductions are available on non-concessional contributions. Hence, this removes any urgency for transferring money out of the reserve account.
SMSF auditors should be care full when auditing funds who allocate previous year's contributions to member accounts in current year as "28 days after the end of the month" rule should be strictly adhered. The ATO has not, to date, issued any clarification as to when and how the allocation to member account has to be done, It is best for trustees to 'err on the side of caution' and stick to the 28-day rule, irrespective of whether contributions held in reserve are concessional or non-concessional and minute the allocation before 28th July.
Fortunately, the last month of the financial year is the time when many trustees do decide to make substantial contributions to their funds so making use of a contribution reserve account to stay within caps may still be prudent.
What happens to contribution reserves if a fund is wound up before the following year?
The balance in the reserve account shall be transferred to the members' accounts before the winding-up or crystallization of the fund and if allocation to member accounts are done in the same financial year, then the member will breach their concessional contribution cap amount.
