SMSFs and residency laws

Bryce Figot and Nathan Papson provide a practical guide for overseas SMSF members.

The number of self-managed superannuation funds (SMSFs) in existence is steadily increasing. Additionally, many industries are moving towards a more ‘global’ workforce, which means there will be a rise in Australians being based overseas for work purposes.

It therefore follows that many SMSF members will be moving overseas for work purposes. There are a number of factors that advisers should consider when they hear their clients with SMSFs are moving overseas.

This article outlines some of the requirements in order to keep the fund as a complying superannuation fund and avoid adverse tax consequences.

Residency requirements

Where an established SMSF has a member who will be based overseas, the SMSF must continue to meet the definition of an Australian superannuation fund for the purposes of the Income Tax Assessment Act 1997 (‘ITAA 1997’) for the fund to continue as a complying superannuation fund. There are three rules that must be considered. These are outlined below.

Rule 1 — established in Australia

Either the SMSF must be established in Australia, or any asset of the SMSF must be situated in Australia. This rule is almost always met.

Rule 2 — central management and control

The central management and control of the SMSF must ordinarily be in Australia. Because Central Management and Control isn’t defined in the ITAA 1997, its definition has evolved from case law.

Case law defines central management and control as being where the real business is carried on (De Beers Consolidated Mines Ltd v Howe [1906] AC 455, 458), and the location where the SMSF’s operations are controlled and directed (Koitaki Para Rubber Estates Limited v FCT (1941) 64 CLR 241, 248).

The Commissioner has agreed with this interpretation and has issued guidance that is in line with the case law above. He has stated that the strategic and high-level decision-making processes must remain in Australia. Some of these processes include:

• Formulating the investment strategy for the fund;

• Reviewing and updating or varying the fund's investment strategy as well as monitoring and reviewing the performance of the fund's investments;

• If the fund has reserves: the formulation of a strategy for their prudential management; and

• Determining how the assets of the fund are to be used to fund member benefits.

Further, the Commissioner is of the view that the day-to-day operations of the fund’s activities will not necessarily constitute central management and control.

Rule 3 — contributions

There are a number of rules concerning the concept of an ‘active member’ (a member who makes contributions to the SMSF). If no contributions are made by any of the members of the SMSF during the time an SMSF member is based overseas, then this rule will be satisfied. We recommend that specific advice be sought if contributions are planned to be made while any SMSF member is a non-resident of Australia.

Implementation

Strategies can be put into place in order to meet the requirements of rules 2 and 3 above.

Enduring power of attorney

A common strategy to keep the SMSF’s central management and control in Australia is for the overseas member to execute an enduring power of attorney in favour of an Australian resident.

The nominated attorney can also act in the non-resident’s place as a trustee (or director of a corporate trustee) of the SMSF without contravening the trustee—member rules (Superannuation Industry (Supervision) Act 1993 (Cth) s 17A(3)(b)(ii)).

As mentioned above, the nominated attorney must undertake the strategic decisions of the SMSF, which may include re-formulating the SMSF’s investment strategy and taking an active role with asset managers, bankers and the fund’s administrators. They must not act as a ‘mere puppet’ of the SMSF member, otherwise the central management and control of the SMSF may be considered as not being in Australia and the SMSF could be rendered non-complying.

Exercise caution with contributions

We have outlined above that it is possible for contributions to be made to an SMSF without it becoming non-complying, while one of the members is a non-resident of Australia. We recommend that caution is exercised and advice is sought before any contributions are made for an SMSF in this situation.

A conservative approach would be to cease all contributions while a member is a non-resident of Australia. Contributions could instead to be made to a large public offer superannuation fund. Then, when the member is an Australian resident again, those benefits rolled into the SMSF.

Effects of non-compliance

This article, so far, has focused on strategies to stop an SMSF from becoming non-complying. The significance of these strategies is that if an SMSF were to become non-complying, it would result in adverse tax consequences for the SMSF. These consequences are broadly outlined below.

• The market value of the SMSF as at the end of financial year before it became non-complying, less the value of any undeducted contributions, is included in the assessable income of the SMSF for the year it became non-complying;

• The concessional tax rate of 15 per cent is lost and the SMSF’s taxable income will be taxed at the highest marginal tax rate (currently 45 per cent); and

• The Commissioner may impose the general interest charge and penalties, where applicable.

No discretion for non-compliance

Ordinarily, where an SMSF is to be made non-complying, the taxpayer can request that the Commissioner exercise discretion regarding whether the SMSF is non-complying, by considering a range of factors (see ATO Practice Statement Law Administration 2006/19 at paragraph 34).

However, where a notice of non-compliance is issued by the Commissioner for the reason that the SMSF fails to meet the definition of an Australian superannuation fund, the Commissioner (or any Tribunal) does not have the power to exercise a discretion.

In CBNP Superannuation Fund v Commissioner of Taxation [2009] AATA 709, an audit contravention report for an in-house asset breach was reported to the Commissioner. Upon further investigations, the Commissioner found that the fund was not a resident superannuation fund and issued a notice of non-compliance for this reason. The taxpayer requested a review by the AAT and ultimately argued that the Tribunal should be able to exercise discretion in relation to the fund being non-complying. Although the Tribunal Member sympathised with the trustee of the fund, it found that no discretion was available and held that the fund did not satisfy the definition of resident superannuation fund.

What to do

Advisers should act swiftly if they have clients with SMSFs who are to be posted overseas in the near future. A small amount of planning (and appropriate structuring) before the member leaves for overseas can avoid an SMSF from become non-complying and also save a significant amount of tax.

Where an adviser becomes aware of, or inherits, an SMSF which has a non-resident member, the arrangements for this SMSF should be reviewed to ensure compliance with the residency requirements. If there appears to be a contravention, expert advice should be sought to see if any other avenues exist.

Nathan Papson is a lawyer and Bryce Figot is a senior associate at DBA Lawyers.