Clients are often very happy to cease being classed as Australian residents for tax purposes as it results in a lower personal tax bill. However, if such clients have self-managed superannuation funds (SMSFs), financial planners must ensure that the residency rules for the fund are met. Failure to meet these rules can result in automatic non-compliance for the fund.
In the real life matter of CBNP Superannuation Fund and Commissioner of Taxation [2009] AATA 709, there was a self-managed superannuation fund with only one member, Ms M. Ms M was also the only director of the fund’s corporate trustee. Ms M ceased to be a resident of Australia for income tax purposes, moving to New Zealand. Ms M installed her brother, Mr M, as a fellow director of the fund’s corporate trustee. Nevertheless, all decisions in relation to the management and control of the fund from then onwards were made by Ms M in New Zealand.
Ms M personally borrowed about $118,000 from fund assets. This loan could give rise to many different contraventions, including:
– a contravention of the limit on investments in in-house assets;
– a contravention of the prohibition on loans to fund members;
– a contravention of the rule that the fund only be maintained for certain core and ancillary purposes (that is, the sole purpose test).
The fund’s auditor focused on the first contravention and reported it to the Commissioner of Taxation. The Commissioner then audited the fund. Upon auditing the fund, the Commissioner realised that the fund failed the residency rules. The Commissioner issued a notice of non-compliance. The fund’s total assets were approximately $273,768. The notice of noncompliance resulted in a tax bill for the fund of approximately $146,000. The fund appealed the notice of noncompliance to the Administrative Appeals Tribunal. The Tribunal found that it was “most unfortunate that Ms M will suffer a significant reduction in her self-managed superannuation fund benefits.
The Tribunal sympathises with her and the position in which she finds herself, but has no greater power than the respondent under the SIS Act to assist her.”Accordingly, the tax liability stood. Whenever a financial planner has a client who is moving overseas, alarm bells should ring and the planner should ask: does the client have a self-managed superannuation fund? If the client does, specific steps must be taken. Failure to take the specific steps can result in a hefty and unnecessary tax bill, as well as little avenue for successful appeal.
Specific steps
There are three key steps to ensure that a self-managed superannuation fund with overseas members meets the residency rules.
First rule Either the fund must have been established in Australia, or any asset of the fund must be situated in Australia. This rule is invariably met.
Second rule The central management and control of the fund must ordinarily remain in Australia. The Commissioner believes that this means the strategic and high-level decision making processes and activities of the fund must ordinarily remain in Australia. He believes that the strategic and high-level decision making 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.
The Commissioner further believes that formalistic or administrative activities do not constitute central management and control. Examples of formalistic or administrative activities include the actual investment of the fund’s assets pursuant to a pre-existing investment strategy. Accordingly, one way to try to meet this rule is to ensure that the fund’s trustees ordinarily only make the strategic and high-level decisions while in Australia. However, this is not the preferred course of action for a number of reasons. One reason is that factually proving where the trustees ordinarily
make the strategic and high-level decisions is easier said than done. The preferred way to meet this rule is to transfer trusteeship (or directorship if a company is the trustee) to a trusted Australian family member or friend. This should happen before the client leaves Australia.
The trusted Australian family member or friend should then centrally manage and control the fund. On its face this poses a problem: the fund no longer appears to be a self-managed superannuation fund as the members are no longer the trustees (or directors of the corporate trustee). However, provided that the trusted Australian family member or friend holds an enduring power of attorney in respect of the members, the fund will still be a self-managed superannuation fund. The Commissioner has set out his views on the uses of enduring powers of attorney in Self Managed Superannuation Fund Ruling SMSFR 2010/2.
Third and final rule Finally, no contributions or rollovers whatsoever should be made to the self-managed superannuation fund while its members are overseas. This is a slight oversimplification of the actual rule, but if clients follow this simplified version, they will never go wrong. If superannuation contributions must be made while clients are overseas, they should be made to a large fund. Then once the clients have resumed being Australian residents again, they can roll benefits from the large fund to the selfmanaged superannuation fund.
Already gone ?
These three rules work well where the planner has the opportunity to plan in advance. However, often work constraints mean clients must leave the country quickly and with little time to properly consult with their financial planner. Accordingly, a financial planner might find him or herself in the tricky position of having an overseas client who has a self-managed superannuation fund where the three rules might not have been followed.
Financial planners should act quickly in this situation and consult an expert for tailored advice to determine whether the fund still meets the residency rules and whether any other avenues exist. With proper planning, clients may move overseas and retain a complying self-managed superannuation fund. However, if the residency rules are not met, the negative consequences can be significant.
