A new ATO ruling released last month helps to clarify what you can and can’t do with property that is under a limited recourse borrowing arrangement (LRBA).

The ruling addresses three key areas:

• Under the borrowing rules in the Superannuation Industry and Supervision (SIS) Act, the borrowing must be used to acquire a “single acquirable asset.”  The ruling seeks to define what constitutes a single asset.
• The borrowing rules allow an asset that is held under a borrowing arrangement to be improved, however, the trustees cannot use borrowed funds to make the improvements. There is a fine line between what is a repair or improvement and the ruling attempts to clarify how the ATO assess the difference between these terms.
• Also, if you do improve the property, any improvement must not result in the asset becoming a different asset.  The ruling looks at the factors the ATO considers, and what your SMSF auditor needs to consider, when they assess whether a property has been changed to such an extent that it is no longer the same asset.

If a fund falls outside of these rules, the fund must sell the asset.  Imagine having to sell a property your fund recently acquired, leaving your fund with the stamp duty, legal and agent’s fees (or perhaps making a loss because the market conditions were not as good as they were when you purchased the property).

Is the property a single asset?

Assuming the fund is able to purchase the asset, the borrowing rules require that the money is used to acquire a single asset.  For example, if the fund purchased a block of units, is the block considered to be one asset or are each of the units inside the block individual assets?

In the ruling the ATO concedes that “it may be possible … that the trustee is acquiring a single object of property notwithstanding that it is comprised of two or more proprietary rights. However, this will only be so where … the separate proprietary rights is distinctly identifiable as a single asset.”  The bottom line is that if the rights can be dealt with separately, then they are not a single asset regardless of how the trustee wants to treat them.

Common examples include:

where the fund acquires a property and the car park is held on a separate title but laws do not allow separation of ownership then there is a single acquirable asset.

where a warehouse is constructed on multiple titles, then there may be a single acquirable asset

Maintenance, repair or improvement?

There has been confusion in this area as ‘maintaining’ ‘repairing’ and ‘improving’ are common terms and not defined in the legislation.  In the ruling, the ATO states:

• Maintaining generally means work done (or in anticipation) to prevent defects, damage or deterioration of an asset provided that it merely ensures the functional efficiency of the asset is maintained in its present state.
• Repairing generally means remedying or making good defects in, damage to, or deterioration of, an asset and contemplates the continued existence of the asset.  The ATO goes on to state that “an asset may be acquired in a state in which a part of the asset is defective, damaged or suffering some deterioration of what would be considered to be its normal level of functional efficiency. Restoration of that part of the asset to its functional efficiency would be a repair for LRBA purposes.”

The ruling seems to suggest that the repair needs to bring the item back to its original condition but not go beyond that.  The cost of the repair in the context of the overall asset is also likely to be a factor in the ATOs assessment of whether or not what has occurred is repair, maintenance or an improvement.

Defining improvement remains a grey area as it is a matter interpretation whether something is merely repaired or maintained or has been improved.

Can you improve a property?

Trustees can use money provisioned under a borrowing arrangement to maintain or repair the property but not improve it.  If the trustees use money from other sources outside of the borrowing, they can improve the property as long as the improvements do not turn it into a different asset.  For example, if the fund borrows money to acquire a vacant block of land and then builds a block of units on it, the asset would be fundamentally changed and considered to be a different asset.

If the fund does not have to borrow money to acquire the property, then the property can be improved as long as the investment decisions are in line with the funds investment strategy (don’t forget to minute key decisions) and all other SIS requirements are met – note there are some traps when using related parties to carry out the improvements.

Property and natural disasters

Trustees can now take some comfort in knowing that they can rebuild an asset that has been destroyed by flood or fire and not breach the borrowing rule.  Using an insurance pay-out in these cases to rebuild what is essentially the same asset that existed prior to the event seems to be allowed.

Get advice!

Despite the clarifications offered by the ruling, the borrowing rules remain complex and rely on subjective decision making.  Trustees should ensure that they seek advice before purchasing, renovating or changing any property held by their fund.

Alex Novello & Grant Moss

http://www.bnm.com.au

The settlement prices for S&P/ASX 200 (XJO) put and call options are used to derive a weighted average of the implied volatility being incorporated into the options. Two maturities are used with the nearby having at least a week until expiry. The volatility of the options closest to maturity is interpolated with that of the options farthest from maturity to arrive at a constant 30 day indication of expected volatility in S&P/ASX 200.1

Uses and interpretation

The volatility index is primarily used as an indicator of investor sentiment and market expectations. A volatility index at relatively high levels implies a market expectation of very large changes in the S&P/ASX 200 over the next 30 days while a relatively low volatility index value implies a market expectation of very little change. Similarly, when the volatility index is at relatively high levels, and market expectation is for high levels of volatility, investor sentiment is perceived to be uncertain. Conversely, when the volatility index is at relatively low levels, market expectation is for low levels of volatility which implies greater levels of investor confidence. Volatility indicators such as the volatility index are often perceived to exhibit characteristics of mean reversion by oscillating around a long term average (or mean). In other words, a move away from the long term average towards high or low extremes is usually followed by a move back towards the long term average. The implication of mean reversion is that high levels of volatility may be followed by a return to more normal levels of volatility and very low levels of volatility may be pre-cursors to an increase in volatility. The volatility index value is similar to rate of return volatility with the volatility index reported as an annualised standard deviation percentage that can be converted to a shorter time period. For instance, a volatility index value of 20% can be converted to a monthly figure remembering that volatility scales at the square root of time. The formula to do this is:

20% x √1/12 = 5.77%

In the above example, index options over the S&P/ASX 200 are incorporating the potential for a one standard deviation return over the next month of +/- 5.77%. More information on volatility index can be found at

www.asx.com.au/volatilityindex

The VIX® — CBOE Volatility Index methodology is the property of the Chicago Board Options Exchange (‘CBOE’). CBOE  has granted Standard & Poor’s Financial Services LLC (‘S&P’), a license to use such methodology to create the S&P/ ASX 200 VIX Index. S&P has granted ASX Ltd a license to use and distribute the S&P/ASX 200 VIX Index, with the  permission of CBOE.

ASX Disclaimer: Information provided is for educational purposes and does not constitute financial product advice.  You should obtain independent advice from an Australian financial services licensee before making any financial  decisions. Although ASX Limited ABN 98 008 624 691 and its related bodies corporate (‘ASX’) has made every  effort to ensure the accuracy of the information as at the date of publication, ASX does not give any warranty or  representation as the accuracy, reliability or completeness of the information. To the extent permitted by law, ASX  and its employees, officers and contractors shall not be liable for any loss or damage arising in any way (including by  way of negligence) from or in connection with any information provided or omitted or from any one acting or refraining  to act in reliance on this information.

S&P Disclaimer: Reproduction of any information obtained from S&P or the S&P/ASX 200 VIX in any form  is prohibited except with the written permission of S&P. S&P does not guarantee the accuracy, adequacy,  completeness or availability of any information and is not responsible for any errors or omissions or for the results  obtained from the use of such information. THERE ARE NO EXPRESS OR IMPLIED WARRANTIES, INCLUDING,  BUT NOT LIMITED TO, WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE.  All information provided by Standard & Poor’s is impersonal and not tailored to the needs of any person, entity  or group of persons. Standard & Poor’s and its affiliates do not sponsor, endorse, sell, promote or manage any  investment fund or other vehicle that is offered by third parties and that seeks to provide an investment return  based on the returns of any Standard & Poor’s index. Individual investors should rely on their own judgment and/or  the judgment of their personal financial advisor in making any investment decisions. In no event shall S&P be liable  for any damages, including but not limited to direct, special or consequential damages, in connections with the use  of S&P/ASX 200 VIX. S&P and STANDARD & POOR’S are registered trademarks of Standard & Poor’s Financial  Services LLC.

February Dividends

February Economic Calendar

February Sector Analysis

February Volatility Analysis

Transition to Retirement

The transition to retirement provisions came about as a result of the need to supplement the income of people wishing to semi-retire. The provisions allow anyone over their preservation age (currently 55) to roll over their super to a Non Commutable Allocated Pension. They can then draw an income from their pension, up to a maximum of 10%, and also subject to a minimum amount. By salary sacrificing to superannuation, and then replacing your income by drawing a monthly pension, those on tax rates of 30% or higher may be able to reduce the total tax payable.

• Rolling over to pension changes the tax on the fund earnings from 15% to zero
• Taking income from a pension (instead of salary) potentially reduces income tax.

There is software available where we can calculate not only your potential tax benefit, but also at what point you can equalise your income, thereby allowing your tax benefit to accumulate as a retirement benefit in your superannuation fund. This strategy is most effective for those with high incomes, high superannuation balances and those aged 60 or more. It may also be effective for anyone over 55 who is still working.

Insurance inside Superannuation

It is common for me to meet people who have cash flow issues, particularly since the Global Financial Crisis. One of the things they decide that they can no longer afford is personal insurance. The problem with this thinking is that if you can’t afford the insurance, then how will you cope if you cannot work for say, six months, and have no income protection? This happened to me years ago, and was not a pleasant experience.

For many people, the best place to hold your personal insurances (life, total and permanent disability and income protection) is inside superannuation. This means that you are not paying for it from your personal cash flow. As long as there is sufficient value in the super to fund the cost of the insurance premiums, then the cash flow problem of paying for the insurance is solved.  The cost is sometimes less inside superannuation than outside, and if you are eligible to make deductible contributions to super, you can pay for your insurance with pre tax dollars.

Large Superannuation Contributions

I have met a number of clients with large lump sums who want to get as much as they can into superannuation. This happened in June this year and my strategy was as follows:

• Make a concessional (tax deductible) contribution to super before the end of June – the maximum is $25,000 if you are under age 50 and $50,000 if you are 50 or over (subject to work test if you are over 65, and ability to contribute ceases at age 75)
• Contribute $150,000 as a non concessional (not tax deductible) contribution before the end of June
• Make another concessional contribution in July up to the maximum ($25,000 or $50,000)
• Contribute $450,000 (non concessional) in July

This allows you to contribute up to $700,000 into superannuation in the space of a few weeks. For a couple over the age of 50, this increases to $1,400,000. It is important to get advice before you contribute. If you get the timing wrong, e.g. pay the $450,000 at the end of June, then you will not be able to make a non concessional contribution (without penalty) for the next two financial years.

Superannuation and Estate Planning

Estate planning is one of those issues that in spite of the fact that most of us don’t want to address it, it won’t go away. We all need to ensure that our assets go to our nominated beneficiaries, and that they are distributed in a tax effective manner. A lack of planning could well result in a boon for the tax office, and less for those we love.

Superannuation can allow for tax effective estate planning. Super is particularly effective if left to a spouse (includes de facto/same sex spouse, interdependency relationship and financial dependant) or minor child (under age 18). There is no lump sum tax payable on the proceeds from a superannuation policy, and if left as a pension to minor children, they are taxed at adult rates. As well as this, a pension when paid to a pension dependant (includes all those listed above) receives a 15% rebate on the income. Let’s look at an example:

If Jack (age 10) receives a pension of $40,000 per annum from his mother, Jill, who died at age 40, how much tax will he pay? We are assuming no tax free portion. It is also important to note that Jack will pay adult tax rates, which are much more generous than child tax rates.

Pension: $40,000

Pension Rebate 15%: $40,000 x 15% = $6,000

Tax on $40,000: $6,000

Tax payable: $6,000 – $6,000 (rebate) = Nil tax payable.

This pension can only continue until Jack turns 25, and then it must be commuted to a tax free lump sum.

There are still a whole host of benefits that super can offer that I have not discussed here. If you have any questions, please send them in and I can answer them in my next article. Of course, for a comprehensive analysis of your own financial position, nothing beats professional advice.

Janne Ashton

www.planprotect.com.au

January Sector Analysis

January Economic Calendar

January Dividends

January XJOIV – Volatility Chart

December Sector Analysis

December Economic Calendar

December Dividends

December XJOIV – Volatility Chart

• Eliminate income tax in retirement
• Eliminate capital gains tax in retirement
• Offset capital gains tax at any age
• Have your contribution matched by the government
• Have a tax effective income from superannuation whilst you are still working

In my next article, I shall have case studies showing how you can use superannuation to:

• Minimise tax on your income whilst saving for retirement
• Contribute $700,000 (per person) to superannuation within a week or so
• Reduce the cost of personal insurance
• Use superannuation in estate planning to minimise tax when passing assets to beneficiaries

Some clients were referred to me last month who were recently retired. They had previously seen two other financial planners. Both planners correctly advised them to put their inheritance into superannuation and from there to an allocated pension, which gives them both tax free income (they are over age 60) and tax free capital gain. The value of this advice (or of using superannuation): over $3,000 p.a.

They also had a parcel of shares outside superannuation. As they were eligible to make a tax deductible contribution to superannuation, I advised them that they could move their shares into superannuation; claim a tax deduction on $50,000 of contributions to superannuation (in this financial year and next), which was enough to get rid of the capital gains tax on the shares as well. This will get their entire portfolio into a tax free environment within 13 months. The value of this advice: $55,000 in capital gains tax (CGT reduced from $55,000 to zero) plus $6,000 p.a. in reduced (to zero) income tax. This is over and above the $3,000 p.a. in the above paragraph.

When you take into account that their life expectancy is over 20 years, the value of this advice goes into the hundreds of thousands of dollars. And none of this could be achieved without superannuation. Where else can you get both tax free income and tax free capital gain? You can get tax free capital gain from your own home, but once you start earning an income from it, e.g. if you rent out a granny flat, then you must pay tax on the income and also on the capital gain derived from that portion of the building.

So, superannuation is great for retirees. But what about those who are still working? Well, there is good news for you too. How would you like a 100% guaranteed return on your investment? For those who qualify, the government will match your contribution to superannuation up to $1,000. This is only on personal contributions on which no tax deduction has been claimed, and is means tested based on your total income before deductions.

Another benefit available from superannuation is the ability to take an income whilst still working if you are over your preservation age (55 for those born prior to 30th June 1960, and increasing each year to 60 for those born 1st July 1964 and later). This strategy can be used to legally reduce your income tax, and also the earnings tax on your investments inside the superannuation environment.

Bear in mind too, that the negative press about superannuation is generally in regards to investment returns. Superannuation is not an investment style; it is a tax effective method of holding investments. You may have superannuation that is invested in cash, fixed interest, shares, property, or a mix of these. It is certainly not necessary to have superannuation invested in shares. So take advantage of the tax treats, and arrange a mix of investments that suits your present and future needs.

The rules regarding superannuation are extremely complex, so it is important to obtain advice to see what strategies are available to you. The examples mentioned here are specific examples of how I have helped particular clients, and are not applicable in all situations. There are of course, other strategies not mentioned here which may be advantageous to you. Give your financial year a positive start by finding out how you can benefit from the tax treats offered by superannuation.

Janne Ashton

www.planprotect.com.au

(1)      Investment control and flexibility

Members of an SMSF have much greater involvement in the fund’s investment decisions and the rules allow them to select specific investments and tailor their own investment strategy thereby giving them a high degree of control over the fund’s investment portfolio.  The investment strategy of an SMSF can be changed from time to time to suit specific member needs and changing economic circumstances and to take advantage of any current investment opportunities.

Specifically, many SMSF trustees prefer to invest directly by purchasing shares, interest bearing securities and real estate as they believe that their decisions can produce better returns than professional superannuation fund managers.  In contrast, members of retail or industry funds have little (if any) control over specific assets, only broad asset categories.

SMSFs are also in a unique position as they are able to acquire certain investments from members which are not available to large corporate, industry or retail superannuation funds.  For example, a SMSF can acquire business real (commercial) property from members and related parties.  This can provide a number of taxation advantages for a client who is able to transfer commercial property they own to the SMSF.

Traditionally, there have been very strict prohibitions on superannuation funds borrowing money.  However, in 2007 the regulations were changed to allow SMSFs to borrow to purchase assets such as property and shares opening up a number of tax planning opportunities for SMSF trustees.

(2)      Tax efficiency

SMSFs are treated exactly the same way as all superannuation funds for tax purposes.  The tax rates for superannuation funds are shown in the table below:

However, SMSFs obtain tax efficiencies through the control and flexibility over investments so that buying and selling can be timed to ensure the greatest tax benefit to the fund. The decision to incur assessable capital gains rests with you. Positions can be held long enough to obtain favourable capital gains treatment.  For example, trustees can construct and manage a portfolio of assets for the very long term in order to defer any capital gains until pension phase.  This involves holding high capital growth investment assets during accumulation phase and then selling them upon commencement of a pension at which point no capital gains tax applies.

Undoubtedly, these concessions are incredibly generous and savvy trustees can reap huge taxation savings from them. SMSFs have a distinct advantage over their retail funds because the trustee role affords them the increased flexibility in the timing of asset purchase and disposal allowing them to tailor their portfolios to maximise tax efficiency and ultimately their member balance.

Finally, given the current tax rates of 30% for companies and 15% for complying superannuation funds, a tax benefit arises where tax can be partially or fully offset through the derivation of franking credits.  SMSF trustees can use franking credits to offset against tax on any income with any excess credits being refundable to the fund.  Many SMSF trustees invest in safe, solid dividend paying companies where the companies’ capacity to frank dividends on an ongoing basis is secure.

This taxation benefit is available to all complying superannuation funds however is skewed towards SMSFs who have greater potential to reap the benefits than retail funds through increased investment flexibility.  This agility allows SMSF trustees to specifically target fully franked dividend paying companies as investments thereby significantly reducing tax on contributions and earnings via the effective use of franking credits.  Conversely, members of retail funds have limited or no control over the level of franking credits they may earn because it is the fund’s portfolio manager who decides what investments to make.

(3)      Cost savings

An SMSF may be more expensive than a retail or industry fund if the SMSF holds minimal assets.  The ATO and ASIC have indicated that it is probably not cost-effective to have a SMSF with assets of less than $200,000.  However, members of retail and industry funds are usually subjected to a myriad of fees many of which fluctuate in direct proportion to their fund balance e.g. entry/exit fees, ongoing management fees, and advice fees.  In contrast, the costs associated with running an SMSF are usually quite transparent and are directly related to the advice and services provided e.g. investment or tax advice, administration, actuarial and audit services.

Rather than percentage based fees, the establishment and recurrent costs of an SMSF are usually flat dollar amounts and therefore form an ever diminishing proportion of total fund expenses as the value of the fund increases.  Furthermore, the compounding effect of cost savings reinvested by the fund can increase the amount of superannuation assets accumulated over the long term.

(4)      Estate Planning opportunities

SMSFs can provide an effective estate planning vehicle which retains investments that may be used for the benefit of future generations.  By introducing younger generations as members of a SMSF and with prudent contribution strategies, it may be possible to build up the fund to provide cash benefits to older generations and preserve assets used in the family business such as commercial real estate.

Is it too complex?

There is no denying that superannuation is complex and performing all the administrative, investment and trustee functions associated with an SMSF yourself is a daunting task. However a professional administrator can help you with the trust deed, fund establishment, actuarial services, statutory obligations, fund reporting, trustee obligations, administration, taxation and audit services. For an active investor who is concerned about their investments but may not have the time, desire or skill to administer their SMSF the job can be made relatively simple.

Michael Fogarty and Rodney Brown

www.catalystsuper.com.au

November Sector Analysis

November Economic Calendar

November Dividends

November XJOIV – Volatility Chart

The occasion of a death cross (when the market’s 50 day moving average falls below its 200 day moving average) is a bad portend for the market since its occurred only three times in eight years. But half of death crosses prove false alarms as we saw in mid 2010.

Analysts are debating whether conditions now are better or worse than they were on the 1^st November 2007 after which the All Ords descended by 55% until the 6^th March 2009.

The case for Better is:

• The last share market peak in April 2011 was still 26% below its previous peak in Nov 2007 so the market has less to fall.
• The forward price/earnings (PE) ratio for the Australian share market is around 10 which is 30% below its 10-year average suggesting shares are already cheap.
• Investors are less leveraged in shares and theUShousing crisis has stabilised though not improved.
• Companies and banks both here and abroad have recapitalised and deleveraged so their balance sheets are much stronger than in 2007.
• Most banks now know their counterparty risk so are lending to each other which they weren’t in 2008.
• The world economy is still growing albeit it slowly. Many companies are enjoying record earnings thanks to cost cutting and productivity improvements.
• The world’s leading central banks by offering 3 month US dollar loans to European banks have demonstrated a resolve to avoid a Lehman Bros like collapse.
• World leaders are much better briefed and prepared for an economic crisis than they were four years ago.
• Germanyhas no choice but to rescue the Euro if it wants to avoid a financial contagion that could plunge it and its neighbours into depression.
• The Chinese craving for Australian resources is set to remain strong helping to prop up our economy even if domestic demand for goods and services is weak.
• America’s Federal Reserve Bank has promised to keep interest rates low for another 2 years and is likely to come to the rescue with more money printing (QE3).
• Australia’s government debt and deficit relative to the country’s GDP is much lower than that of almost every other developed country making us a safe haven. See chart below.

The case for Worse is:

• The global financial crisis (GFC) never went away – the excessive and toxic debt of banks was merely shifted to governments and central banks.
• Large economies likeItalyandSpainrisk a debt trap likeGreece,IrelandandPortugal, yet are too big to be rescued by the European Central Bank.
• Many European banks are heavily exposed to the debt of Mediterranean countries which if they default will leave the banks insolvent.
• Americahas lost its triple-A credit status and could be downgraded further proving it’s no longer too big to fail especially if the US dollar lost its reserve currency status.
• Governments now have too much debt and too large deficits to afford another round of stimulus and rescue packages.
• Central banks have cut their interest rates to almost zero so can’t cut them further to avoid a double dip recession.
• Central banks risk more asset bubbles like those of commodities, precious metals and shares if they turn to the printing presses once more.
• Three in four German voters oppose their government rescuingGreeceor any other country so their Parliament may not approve further action.
• Political leaders around the world no longer have the political authority or fiscal ammunition to act decisively should there be another meltdown.
• Chinais already battling high price inflation (6.4% per annum) so won’t resort to a massive fiscal and monetary boost as it did in 2008.
• P/E ratios only look low because earnings have been boosted by government stimulus which now is going into reverse inAmericaand elsewhere (see next chart).

How the ongoing GFC drama pans out from here on no one knows. But what we can say is that being out of the market at present is being out of harm’s way. Should it crash further a trend-timers like myself shall continue to stand back and watch it fall until the trend reverses. Should it bounce back we will catch the uptrend for as long as its lasts. Bear markets are manna for market timers because they eventually allow us to buy back shares (i.e. exchange traded funds) at fire sale prices.

Investors without an objective and disciplined market timing system intently watch the news and worry whether to exit the market or hang on. And if they have already left the market they are not sure when to return.

It’s interesting to observe the contradictory opinions of so called market experts since it corrected. Most fall into the category of “we have been telling you the market is sick for a long time” or “everything will be OK as long as you hang on for the long term”.

The first group never alerted their readers when to actually get out of the market. The second group refuse to acknowledge we have been in a secular bear market since late 2007 (Americasince 2000) which based on precedents (1929-42 and 1966-82) could last for a long time.

During such periods ordinary share investors experience a rollercoaster ride only to accrue dividends assuming the companies they have invested in survive. In real terms (after inflation) they lose capital. By contrast a trend follower uses exchange traded funds (that diversify company risk) catch the market’s upswings and avoid its downswings having a smoother ride and making good money.

Note in the next chart how even an ultra-conservative trend-timing strategy (which issues the very few buy and sell signals) avoided the worst of the 2008 crash yet got back into the market in s time to enjoy the strong rally of 2009.

Trend traders that adhere to a proven strategy can relax knowing they are on the right side of the market whether it’s soaring or correcting. Yes, there are occasional whipsaws, but these are small insurance premiums for staying out of every crash and catching every rebound.

Percy Allan is Chairman of Market Timing Pty Ltd. For more information about trend-trading visit www.markettiming.com.au