Previously, ClearLaw has described how an SMSF may lose its concessional tax status if its members spend time overseas. Changes to superannuation tax law since that ClearLaw bulletin have made the residency trap harder to avoid.
What are the changes?
The changes to SMSF residency rules:
- were effected as part of some general reforms to superannuation law;
- involved some rewriting of the relevant legislation — most importantly relating to the exception to the trustee presence rule; and
- shifted all the relevant rules into the Income Tax Assessment Act 1997 (ITAA97).1
The basic rule — 'Australian superannuation fund'
For an SMSF to be a 'complying fund' and to receive concessional tax treatment, it must be an 'Australian superannuation fund'. To be an Australian superannuation fund, the SMSF must:
- be established in Australia or have an asset in Australia — this is easy;
- observe the trustee presence rule — this is more difficult; and
- observe the active members asset rule — this rule can catch the unwary.
We focus on the trustee presence rule as this is the only rule affected by the changes. (The other rules are summarised below.)
What is the trustee presence rule?
Under the trustee presence rule, the central management and control of the SMSF must be in Australia. In summary, this rule holds that:
- The central management and control of an SMSF is where its trustee or trustees principally make decisions about the SMSF;
- If the trustees, or the directors of the trustee, are overseas, then (regardless of whether they are Australian tax residents) the central management and control will also be overseas; and
- If they remain overseas for more than 2 years, then the SMSF:
- will fail the trustee presence rule;
- will therefore become a non-resident fund; and
- will incur a tax penalty.
What is the exception to the trustee presence rule and how was it changed?
The old exception — 28 days every 2 years
Under the old provisions2, the trustees or directors of the trustee could return to Australia for 28 days to restart the 2 year period — easy, just visit friends and family and take in a test match or the tennis once every 2 years. Regardless of how permanent the trustees' (or directors of the trustee's) move overseas is, the fund would still comply with the trustee presence rule.
The new rule — no more than 2 years
The new provision provides that:3
- the central management and control of a superannuation fund is ordinarily in Australia at a time even if that central management and control is temporarily outside Australia for a period of not more than 2 years.
This changes the trustee presence rule because:
- the SMSF trustees must demonstrate that:
- their absence was temporary; and
- no longer than 2 years (in most circumstances you would think if any absence period is less than 2 years, it is temporary);
- there is no express exception — returning for 28 days every 2 years may not help; and
- the SMSF trustee (or directors of the trustee) will have to break up any period overseas into different 'temporary' periods. The main issue here is that this is a somewhat arbitrary question and there is no protection of a defined 28 day 'return' period.
What are the other rules and have they changed?
The other requirements for an SMSF to be an 'Australian superannuation fund' did not change in the reforms. They are:
The establishment rule
The SMSF must either:
- have been established in Australia — this will be the case almost all of the time; or
- have any of its assets situated in Australia — so SMSFs not established in Australia need to make sure that at least one asset is situated in Australia at all times.
There is no exception to this rule.
The active members asset rule
This rule is satisfied if:
- non-resident members have (in total) no more than 50% of the total entitlements which active members have in the fund; or
- the accumulated entitlements of non-resident active members is no more than 50% of the total entitlements which active members have in the fund — unless an exception applies.
Generally speaking, an active member is a member who is currently contributing to the SMSF, or who is resident in Australia and on whose behalf contributions are being made to the SMSF.
However, there is also an exception to this rule. The amount of active member entitlements does not include those of a member:
- who does not contribute to the fund when they are non-resident; and
- who does not have contributions made by their employer to the fund in respect of periods of non-residency.
This exception is available because the member is considered non-active.
But, even if that exception applies, a member who is a non-active and non-resident member will still present a problem to the SMSF if they are overseas for more than 2 years. This is because the SMSF will not be able to comply with the trustee presence rule.
Protecting the SMSF from the residency trap
The ATO continues to state that it will monitor the residency status of SMSFs.
Accordingly, if the trustees, or the directors of a trustee, of an SMSF will be absent from Australia for more than 2 years, then they should consider either:
- converting the SMSF to a small APRA regulated superannuation fund with a professional trustee; or
- rolling the entitlements from the SMSF into a retail or industry superannuation fund.
However, each of these measures:
- may result in an increase in management costs;
- may result in different insurance arrangements;
- may involve having to liquidate the investments in the fund for the purpose of the rollover; and
- would likely have tax implications.
Therefore they should be considered carefully, and as always, should be the subject of professional advice.
Alternatively, SMSF trustees may wish to consider seeking advice about appointing attorneys to manage the SMSF during the extended absence. There are a number of risks associated with this strategy — including in relation to surrendering control over retirement assets to non-professional trustees. Accordingly, such a step should not be considered lightly.