Most people are unaware that a self managed super fund (SMSF) with non-resident trustees and members may be ‘non-complying’.
“Why is that a problem?” I hear you ask. It’s because if a SMSF is found to be non-complying by failing any of three “residency tests”, not only are the earnings received during the financial year taxed at 45 per cent (instead of a maximum of 15%), but also the sum of the market value of all the fund’s assets (just before the start of the income year, less any member contributions where no tax deduction has been claimed), are also all taxed at a flat rate of 45 per cent.
Imagine a $1 million fund where all the assets are taxed at 45%. That would be a $450,000 penalty!
Can you do anything about it? The answer is “Yes!”
Definition of a complying resident Australian super fund
To get the technical stuff out of the way, in order to be a complying super fund in relation to a year of income, and provide you with the tax benefits that super receives, section 42 of the Superannuation Industry (Supervision) Act 1993 (SISA) provides that the fund must, among other things, be a ‘resident-regulated superannuation fund’ at all times.
Section 10 of SISA defines ‘resident-regulated superannuation fund’ as a regulated super fund that is an Australian super fund within the meaning of the Income Tax Assessment Act 1997 (ITAA).
The definition of ‘Australian superannuation fund’ has three tests, which are commonly referred to as “residency tests” (covered in ss 295-95(2) of the ITAA 1997). Therefore, a super fund qualifies for concessional tax treatment only if it passes these residency tests.
For income tax purposes, provided a fund satisfies the definition of ‘Australian superannuation fund’ at any time during an income year, it will be an Australian superannuation fund for the income year in which that time occurs. Only when a fund satisfies the definition of ‘Australian superannuation fund’ at all times, is it a complying fund within the meaning of SISA.
The three tests that must be met for an SMSF to maintain its residency status are:
- the fund was established in Australia, or any asset of the fund is situated in Australia at that time; and
- at that time, the central management and control (CM&C) of the fund is ordinarily in Australia; and
- at that time either the fund had no active members or at least 50% of the super account balance in the SMSF belongs to ‘resident active members’.
Most funds meet the first test if they are established in Australia.
The Central Management & Control test
CM&C is a difficult one because you have to look at what the deed says about the voting powers of the members. If it is one member, one vote, and it is a four member fund and one of the members has moved overseas, CM&C might be said to remain in Australia.
But some deeds apportion the decision making power based on the balance of each member’s account and others are based on the number of shares held in the trustee company. If the non-resident has the higher proportion of voting rights, it cannot be said that the CM&C is ordinarily in Australia.
Another question is: who is the dominant trustee (i.e. a husband and wife might, on paper, have equal voting rights but in reality a dominant person makes all the key decisions). If that is the case, CM&C would not be in Australia.
The common solutions for the CM&C test is to examine the facts, and for the trustees to either document their intention of temporary absence in the minutes of a meeting, or delegate trustee duties to an Australian resident to exercise CM&C if it’s hard to establish the departure is on a temporary basis.
Importantly, SIS legislation allows a legal personal representative (LPR) who holds an enduring power of attorney (EPoA) to be appointed as a trustee or a director of the trustee company in place of the member. Many Australians who are trustees and active members of their SMSF who choose to take up an employment position overseas for a number of years appoint their LPR as Attorney under an EPoA and resign as director of the corporate trustee and appoint the Attorney under the constitution of the company and the terms of the deed. It is a requirement under s 17A(3)(b)(ii) SISA (CM&C) for the fund to remain a SMSF.
However, it is not simply a matter of ‘acting on behalf of the member’. There is an actual requirement for the trustee to resign and the LPR to be appointed in their place. That is, the LRP, acting under an EPoA, is not acting as an agent or proxy of the non-resident member. That member must resign as trustee or as director of the corporate trustee for CM&C to be seen as ordinarily being in Australia.
The Active Member Test
To pass the active member test, the most secure method is probably to arrange for the members going overseas to have contributions made outside of their SMSF, for example, through a separate retail or industry super fund, and then rollover the contributions made to their SMSF when they return as an Australian resident (not before).
This is very important where the non-resident member has more than 50% of the fund balance. He or she could not be active if the SMSF is to be judged as complying.
But what does it mean to be an active member?
A member is an active member of a super fund at a particular time if the member is a contributor to the fund at that time or is an individual on whose behalf contributions have been made.
In other words, if an employer contribution was made to the fund, or if the fund needed a contribution to fund a purchase or boost fund liquidity to maintain life insurance premiums or pay the fund administration or accounting bill, it would breach the active member test if the member in respect of whom the contribution was made were a non-resident, and the fund would be non-compliant.
Another solution could be winding up the SMSF
As mentioned earlier, the penalty for non-compliance of the residency tests is harsh.
Rather than subject the fund to this penalty, it might be better to wind up the fund and rollover the proceeds to a public offer retail super fund. Keep in mind also that the Commissioner of Taxation has no discretion to avoid applying the punitive treatment to non-resident funds.
Professional advice is critical
It could be expensive for anyone to retain a SMSF and move overseas to live and work without first getting qualified and professional advice because something so simple as a contribution on behalf of the non-resident member can make the fund non-compliant – an expensive mistake.
Keep in mind, also, this article does not cover every contingency, trick and trap. Your accountant or financial adviser will be able to look at the options available to you to ensure your superannuation position is appropriate while you are away.
How can we help?
If you have any questions or would like to how we can help you with your SMSF administration please contact us via firstname.lastname@example.org.
Jason is able to provide you with personalised financial advice about Superannuation & Retirement Planning through his Australian Financial Services License with Three Chairs Financial Services.
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The information contained in this article is general in nature and does not take into account your personal situation or objectives. You should not act on this information in any way before seeking professional advice.