Banning in-house assets – the right solution?

It occurred to me that the Cooper Review panel’s recommendation to ban in-house assets (IHA) for SMSFs has failed to get to the core of the issue and has not given due consideration to the impact of other recommendations in the Cooper report.

The review panel made a recommendation that SMSFs should no longer be able to invest in IHA. The main reason they give is that these investments “provide an avenue for potential abuse”.

The ATO has indicated that generally where trustees are breaching IHA rules, they are REALLY getting it wrong; that is, they are investing hefty portions of the fund’s assets in IHA, far in excess of the 5% allowed.

The panel does not appear to consider the fact that prohibiting IHA may not actually change trustee behaviour. If trustees are already breaching the existing rule to limit IHA to 5% of the fund’s assets, why would a new rule prohibiting these investments change that behaviour? In my view, some of the other recommendations may provide a better solution.

For example, one of the more commendable recommendations is for greater sliding scale penalties being available for the ATO to impose on SMSF trustees, including monetary fines, mandatory education and rectification orders. Because the penalties would be better aligned with the level of the breach, this would more likely succeed in changing trustee behaviour. Under the current regime, the upper end of the penalty scale is rarely imposed because of extreme implications for trustees and their retirement savings.

Another example is the audit function. Clearly, trustees are being reported to the ATO where they breach the IHA rules (16% of reported contraventions). While I don’t agree with the specific recommendations on SMSF auditors in the report (in fact, I strongly disagree with them), I do agree with the sentiment that auditor competencies and independence is important and that more can be done to enhance the audit service offering. To this end, an improved audit sector will see that trustees breaching IHA rules continue to be reported to the ATO.

Banning IHA was not the right solution for the potential or actual abuse of these rules – methods to modify trustee behaviours are.