A reserve is an amount held within a SMSF that is not allocated specifically to members. Generally, reserves are permitted unless specifically prohibited under a SMSF’s governing rules. Prior to 1 July 2017, a wide range of reserves were used by some SMSFs as follows:
- investment smoothing;
- insurance; and
Investment smoothing reserves are used to maintain a consistent rate of return for the fund and are widely used by APRA funds; however, their use in a SMSF is not likely to be valid given the limited membership size available. SMSFs with historical investment reserves are encouraged to develop a plan to unwind these reserves over time and audit checks include identifying if the reserve has been added to since 1 July 2017.
Prior to 1 July 2019, anti‑detriment payment reserves were utilised in order to fund ‘tax saving amount(s)’ in accordance with sections 295-485 of the ITAA 1997. These reserves were established to pay an additional benefit upon death, equivalent to the tax already paid on contributions, for the member. The reserves were funded from excess investment returns, by a contract for insurance over the life of a fund member or allocated from miscellaneous reserves. SMSFs were able to pay a tax savings amount to a deceased’s member’s spouse or child up to 30 June 2019 provided the member died prior to 1 July 2017.
Audit procedures for a SMSF with an anti-detriment reserve may include ensuring the trustee has documented the strategy in respect of the capital and, where the reserve is being unwound, the treatment of allocations from the reserve to member balances.
Funding of reserves via the use of a contract for insurance was prohibited from 1 July 2014; however, if the policy was commenced prior to the change, the SMSF can continue to maintain it. Audit procedures may include testing insurance contracts against the requirements of regulation 4.07D of the SISR.
General reserves are created in a SMSF by the death of a defined benefit pensioner as any residual capital remaining from the pension defaults to a reserve as the capital is not a member allocated balance.
Contribution reserves are not considered to be a reserve and are referred to as an ‘unallocated contribution suspense account’. The use of this account allows funds to manage potential excess contributions, where a contribution is received within the month of June. Contributions received are required by the SISR to be allocated to members within 28 days of the end of the month in which they are received. If a SMSF receives a contribution during a financial period and that contribution is not allocated to a member in that period, the amount should be classified as an unallocated contribution at balance date. The unallocated contributions account is similar in nature to a reserve, but contains only contributions held temporarily until they are allocated. Earnings and expenses may not be debited or credited to the unallocated contributions account.
The trustee is required to report an unallocated contribution to the ATO via a specified form, otherwise the member will be assessed under the excess contributions rules.
The ATO has issued SMSF Regulator’s Bulletin SMSFRB 2018/1 to provide its interpretation of the validity of reserves for SMSFs and its concerns that reserves may be used to circumvent the various caps and limitations that apply to superannuation and income tax from 1 July 2017.
Audit considerations for reserves include whether:
- the fund’s governing rules permit the maintenance of reserves;
- the fund has a reserve strategy;
- the assets of the particular reserve are segregated appropriately from the rest of the SMSF’s assets;
- amounts transferred in or out of the reserves are appropriate. An allocation from a reserve (excluding a pension reserve) is treated as a concessional contribution, unless the allocation is ‘fair and reasonable’ across the membership and the amount allocated represents less than 5 per cent of the member’s balance. Pension reserve transfers are in accordance with the annual actuarial certificate; and
- where a SMSF has reserves that were established prior to 1 July 2017 (or 2014 for insurance), the fund is permitted to maintain the reserve; however, unexplained increases in the balance of fund reserves and the creation of new reserves are subject to greater scrutiny.
See regulation 7.08 of the SISR.
See ATO Taxation Determination TD 2013/22, which applies from 1 July 2013. ATO ID 2012/16 applied prior to 1 July 2013.
See ATO form NAT 74851 Request to adjust concessional contributions.
See subsection 52B(2)(g) of the SISA.