SMSF Members overseas? Beware the residency trap
Fund residency requirements generally
For an SMSF to be a 'complying fund' and receive concessional tax treatment, the SMSF must be an Australian resident fund. SMSFs are at risk of losing their complying status, if their members spend time working overseas. This is because the residency rules require trustees and the majority of contributing members to reside in Australia.
For a fund to remain resident, the fund has to satisfy the residency rules throughout an income year — unless an exception applies.
The trustees' presence rule
Generally speaking, for SMSFs, the individual trustees of the fund must be the same people as thefund's members. Similarly, if a fund has a corporate trustee, then the directors of the trustee company must be the same people as the fund's members.
Under the residency rules, central management and control of the SMSF must be in Australia: this implies that the trustee directors or individual trustees must function in Australia. Although these are commonly called residency rules, on closer examination they actually involve a physical presence test, rather than a residency test.
The exception to the trustees' presence rule
However, there is one exception: a trustee or director may be absent from Australia for a continuous period of up to 2 years and still not jeopardise the fund's complying status. To start the 2 year period again, the person must return to Australia for a visit of more than 28 days.
The risk to the SMSF by a breach of the trustees' presence rule
The problem then, is that an overseas assignment of more than 2 years may well pose a residency problem for an SMSF — unless the assignment is broken by a return to Australia for a month or more.
The active members asset rule
Non-resident members must not have more than 50% of the total fund of active members
Member residency requirements revolve around the concept of an "active" member. Generally speaking, an active member is a member who is resident in Australia and currently contributing to the SMSF, or having contributions made by their employer to the SMSF.
Under another rule, the accumulated entitlements of non-resident active members must not exceed 50% of the entitlements of total active members — unless an exception applies.
The exception to the active members asset rule
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.
Non-active, non-resident members still cause a problem...down the track
Even if that exception applies, a non-active, 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 trustees' presence rule.
Why is it important for a fund to maintain its residency status?
A fund needs to maintain its residency status. If a fund loses its residency status:
- it will no longer be "complying";
- the tax rate on its income and gains increases from 15% to 45%;
- a tax of 45% of its assets applies in the year it becomes non-complying;
- a tax of 45% of the assets applies again if it then becomes complying again;
- it loses the discount for certain realised capital gains;
- it loses the exemption for income supporting current pensions;
- it loses exemption of income flowing from life policy investments and PST unit realisations; and
- it loses deductions for life and disability insurance premiums.
The ATO's approach
The ATO has indicated at recent industry forums, that:
- it has no discretion to ignore a fund's non-compliance arising from non-resident status; and
- it will be monitoring the residency status of SMSFs.
Funds can avoid residency problems
Planning an overseas assignment
It is crucial to seek advice on how a SMSF will be managed, before members go overseas. Although a member/trustee may plan to be away for less than 2 years, a change of plan to extend the trip may have disastrous results.
If one or more remaining resident members have:
- more than 50% of the fund's assets, then this will still satisfy the 50% resident active member requirement , and contributions may continue. However, it will be important to carefully monitor the situation in case those balances change or the intentions of the remaining resident members change; or
- less than 50% of the fund's assets, then this will not satisfy the test. However, this problem may be avoided if during a period of non-residency, the contributions of the remaining resident members cease and no employer support is providedÔ?? that is, the remaining members become non-active. However, the fund will still have to comply with the trustees' presence rule
It is important to seek advice about maintaining central management and control in Australia. It is not enough that the trustees may remain resident for tax purposes.
The legislation requires the trustees to be present in Australia, unless the 2 year concession applies. If a majority of the trustees/members remain in Australia or satisfy the 2 year rule, then it may be possible to put forward a case supporting Australian management and control. However, it is crucial to plan ahead and monitor to ensure that compliance is achieved.
What you should plan for
If there is any doubt about the central management and control of the fund, it would be prudent to plan for:
Replacing the trustees:
This could be done by converting the SMSF to a small APRA fund with a professional trustee. This approach would generally enable the fund to continue its existing investments and strategy — as long as the new trustee agrees with the existing investment strategy. However, there are increased costs to engage a professional trustee and increased regulatory fees.
Transferring entitlements to another fund:
Another approach is to consider winding up the fund and transferring the entitlements to a larger fund. However, the trustees would lose control over the specific assets: Also larger funds are most unlikely to accept the transfer of the member's specific assets. This means that the SMSF's assets may have to be converted to cash first (with duty and CGT consequences). However, one benefit is that administrative burdens and compliance concerns become a thing of the past.
These choices should be carefully considered in the context of members' long term plans.
For more information, contact Maddocks on (03) 9288 0555 and ask for Julian Smith or Bernie O'Sullivan.