On 8 August 2014, the Australian Investments and Securities Commission (ASIC) issued a media release – 14-191MR Statement on wholesale and retail investors and SMSFs (14-191MR), in which ASIC withdrew its previous view on the application of the wholesale investor test to self-managed superannuation funds (SMSFs).
As ASIC notes, there has been significant uncertainty regarding the circumstances in which a SMSF may be treated as a wholesale client for the purposes of the Corporations Act 2001 (Corporations Act).
Accordingly, clarification of ASIC's position will come as welcome news to both SMSF trustees and Australian Financial Services License (AFSL) holders who provide financial services to SMSFs. Unfortunately however, there are still some uncertainties regarding the application of the wholesale investor test as it applies to SMSFs.
Wholesale Investor Test
The Corporations Act outlines the circumstances in which a person will be considered a wholesale client. If none of these apply, the client must be treated as retail.
Financial Services Relating to a Superannuation Product
Under the Corporations Act, where a financial service which "relates to a superannuation product" is provided to a SMSF trustee, the trustee must be treated as a retail client unless the SMSF has net assets of AUD10 million or more.
In 2004, ASIC issued a frequently asked question response, QFS 150, which stated that a financial service would generally relate to a superannuation product in a situation where financial services were provided to the trustee of a SMSF. As a result, ASIC suggested that a SMSF with less than AUD10 million in net assets must always be treated as a retail client, regardless of the nature and content of the advice being provided or the sophistication of the client.
Throughout the last 10 years, much discussion has been had about whether ASIC's stated position in QFS 150 was a correct interpretation of the law, and a number of alternate views have gained currency.
In 14-191MR, ASIC now states that it has withdrawn QFS 150 and that where the financial service provided to a SMSF trustee does not relate to a superannuation product, the general test for determining whether a client is retail or wholesale applies.
ASIC gives two very commonplace examples of a financial service that will not relate to a superannuation product:
where the trustee of an existing SMSF receives advice about how to invest the fund's assets
where a trustee subscribes to a financial product on behalf of an existing fund.
As a result, in these circumstances AFSL holders will need to refer to the usual rules to determine whether a SMSF trustee may be treated as a wholesale client these include:
if the price of the financial product or the value of the financial service is equal to or more than AUD500,000 (Product Value Test)
if the person the financial product is issued to, or the financial service is provided to, has net assets of at least AUD2.5 million (Asset Test)
if the person the financial product is issued to, or the financial service is provided to, has had gross income for each of the previous two financial years of at least AUD250,000 per year (Income Test)
if the financial product is issued to, or the financial service is provided to, a company or trust who is controlled by a person who meets the Asset Test or the Income Test (Control Test).
Where a SMSF Can be Considered as a Wholesale Investor
The withdrawal of QFS 150 provides SMSF trustees and AFSL holders with a greater degree of certainty in relation to the application of the wholesale investor test.
Where the financial service does not relate to a superannuation product, it seems clear that a SMSF trustee can be treated as a wholesale investor in the following circumstances:
The SMSF trustee is making an investment that satisfies the Product Value Test. Here the trustee may be treated as wholesale for the purposes of the financial services relating to that investment.
The SMSF has a corporate trustee with a sole director who satisfies the Asset Test or Income Test in their own right. In these circumstances, the director (who must also be the sole member of the SMSF under superannuation law) controls the SMSF for the purposes of the Corporations Act. Therefore, the Control Test is satisfied in respect of the SMSF trustee.
A SMSF with a corporate trustee satisfies the Asset Test or the Income Test based on the net assets or net income in the SMSF itself. The Corporations Act states that for the purposes of determining the assets or income of a person (ie the SMSF trustee) the assets of a trust controlled by that person may be included. Therefore, because a corporate trustee can be said to control a SMSF, the assets of the SMSF may be used in determining whether the corporate trustee is a wholesale client.
A SMSF has individual trustees who all satisfy the Asset or Income Test in their own right. In these circumstances the trustees are wholesale clients and can be treated as such in respect of advice relating to the SMSF.
Lingering Uncertainties About Whether a SMSF Is a Wholesale Investor
While ASIC has provided clarification in 14-194MR, there are still uncertainties surrounding how to apply the wholesale investor test to SMSF trustees in some circumstances, including the following:
The definition of superannuation product is a "beneficial interest in a superannuation entity" which is a broad concept that remains a source of confusion. While ASIC has given examples of a financial service that will not relate to a superannuation product test, there is still very little clarity as to when it will.
To whom is the Asset Test or Income Test applied where there is no clear answer as to who controls the SMSF? For example, consider where a SMSF has a corporate trustee with two or more directors and it cannot be demonstrated that a particular director has the capacity to determine the outcome of decisions about the SMSF. In circumstances where the SMSF does not have the relevant assets or income, there are differing views as to how the Control Test will apply. It may be that some people in the industry are interpreting it in such a way that none of the directors' assets may be taken into account, even where they may have significant wealth, while others consider that this would be adequate to demonstrate that the SMSF trustee is a wholesale client.
Where there are multiple individual trustees who do not individually meet the Asset or Income Tests, a particular provision of the Corporations Act suggests that their assets and income could be combined to satisfy the tests. This provision states that where a trust has multiple trustees, the relevant sections should apply to the trustees as if they constituted a single legal entity.
The above examples highlight that although ASIC's clarification in 14-191MR was useful, there are still difficulties in applying the wholesale investor test to SMSF trustees.
SMSF Specific Wholesale Investor Test
SMSFs are an extremely large and growing sector of the financial services industry and the uncertainties that still surround the Wholesale Investor Test as it applies to them are unfortunate. In 14-191MR, ASIC specifically states that it supports a more general review of the test to ensure that it is both clear and appropriate.
Now is the right time for a review, in light of both ASIC's recognition of the uncertainties and with the Financial System Inquiry underway.
In our view, there should be legislative change to create a separate test for SMSF trustees which would apply to the exclusion of the existing tests. The test should be straightforward in its application and should apply equally to all SMSF trustees regardless of their structure.
ASIC's initial view, described in 2004 in QFS 150, was a contributor to the confusion surrounding the application of the wholesale test to SMSFs. Its withdrawal comes as a welcome move by ASIC.
There is however, remaining uncertainty surrounding the Wholesale Investor Test as it applies to SMSFs. We suggest, however, that these remaining uncertainties could best be addressed via the introduction of a straightforward SMSF-Specific Wholesale Investor Test.