Residency matters

There is no point in establishing an SMSF if it cannot be classified as an Australian superannuation fund. BT head of financial literacy and advocacy Bryan Ashenden looks at how this definition can be satisfied and the severe consequences should a fund lose this status.

In a world that has returned to a somewhat normal state following COVID-19, the ability to travel and work internationally has opened up again. Extended periods of time outside of Australia can present great opportunities for clients. Travel offers new experiences and enriches the soul, but also in some cases the ability to earn more or possibly minimise tax.

During times like these, clients may be looking for ways to invest some of their wealth and the low-tax environment of superannuation looks attractive. However, especially where a client has an SMSF, travelling overseas can introduce the risk of the fund losing its complying status and therefore its concessional tax treatment.

The good news is there are strategies to minimise this danger. Additionally, the previous coalition government announced it would introduce measures to remove some of the concerns in this area. The current Labor government has indicated its support to continue with these amendments, but at the time of writing this article it had not yet introduced this measure into federal parliament in the form of a bill.

Before we turn to the strategies and future potential changes, it is important to start by looking at the requirements to be a complying fund and, in this case, what is required to be, and remain, classified as a resident Australian superannuation fund. To meet this requirement, three tests need to be satisfied.

The first test – establishment and investments

To satisfy the first test, there are two options available and only one of these needs to have been met. Firstly, the SMSF needs to have been established in Australia. In most cases when we think about where a fund was established, we normally think about where the SMSF trust deed, the signal for commencement of the fund, was executed and this would invariably be within Australia for the majority of cases. However, the location of execution of the trust deed is irrelevant in this case. Rather, a fund is considered to be established in Australia if the initial contribution made to set up the fund was paid and accepted here. Again, in most cases this will be satisfied, but it could be an area of which to be conscious if the SMSF was established when the trustees were overseas, meaning the initial contribution, while received in an Australian bank account, could have been paid from an offshore account. Note, satisfying this option is a point-in-time option at establishment. If met at establishment, this first test is passed and can never be failed.

The alternative option under this initial test is for at least one of the fund’s assets to be located in Australia. This test is relevant for the point in time, or for the income year, in which you are looking to apply this first test. It does not require all of the SMSF’s monies to be invested in Australian assets at all times. Rather, at some time during the income year at least one asset of the fund was located in Australia. Arguably, this would be met on an ongoing basis if the SMSF has an Australian bank account.

The second test – central management and control

The second test requires that central management and control of the fund is ordinarily in Australia. In simple terms this means the SMSF’s strategic decisions are regularly made and high-level duties and activities are performed in Australia. Within these parameters are decisions such as:

• formulating the investment strategy of the fund,

• reviewing the performance of the fund’s investments,

• formulating a strategy for the prudential management of any reserves, and

• determining how assets are to be used for member benefits.

Certain other activities that are important in the running of an SMSF do not constitute central management and control tasks. These include the acceptance of contributions made on a regular basis, the actual investment of the fund’s assets, the fulfilment of administrative duties and the preservation, payment and portability of benefits. Rather than decision-making tasks, they are more administrative in nature or are tasks to execute strategy rather than formulate it.

To satisfy the requirements of this test, we need to see who is making the decisions relevant to central management and control and where the individual is located at the time of making those decisions. For this, you would normally look to the location of the trustees (for an individual trustee SMSF) or the directors (for a corporate trustee SMSF).

This could therefore become an issue if the clients (trustees/directors) are currently outside Australia. While a person could be appointed under an enduring power of attorney to act on behalf of the trustees when they are overseas, this would only negate this issue if the attorney had the ability to make decisions on their own and were not seen to be merely implementing decisions at the direction of the overseas trustees.

For clients who have left Australia there is some potential relief provided by way of current law. Under existing section 295-95(4) of the Income Tax Assessment Act 1997, “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 two years”.

The critical element for this provision to operate is whether the trustees’ absence is temporary in nature and is tested at the time of the absence. There is no simple, hard and fast rule for determining whether an absence is permanent or temporary. Some of the factors that could be taken into account in trying to determine an outcome include establishing:

• if the trustees maintained a residence in Australia (whether owned or rented) for the period of their absence or if they purchased a new place of residence outside Australia,

• if the trustees retained their furnishings, or

• whether other possessions, such as cars, have been retained or disposed of.

There is a question of whether the twoyear period could be reset, for example, by having the trustees return to Australia for a period of time and exercise trustee duties in Australia while here before departing again. It may be possible, but the question comes back to whether the absence should be viewed as a temporary absence, or a series of temporary absences, or whether in fact the absence is more permanent in nature.

It is in this area where a legislative amendment proposed by the former coalition government would be of potential assistance. It had been proposed to extend the period of an allowable temporary absence from two years to a higher duration of five years. The current government has indicated its support for this measure, announcing it will commence from the next 1 July after the amending legislation receives royal assent. Unfortunately, however, at time of writing a bill that would give effect to this change has yet to be introduced into parliament. On that basis, the current earliest start date for such a change, based on the stipulated timeline, would be 1 July 2024.

The third test – active members

Under this third and final test, it is a requirement for the fund to either have no active members or, if it does, have at least one active member. Active members are individuals who are Australian residents and hold at least 50 per cent of either:

• the total market value of the fund’s assets attributable to super interests, or

• the sum of the amounts that would be payable to active members if they decided to leave the fund.

A person will be an active member if they are a contributor to the fund at a particular point in time. In essence, this turns on the question: are they making contributions to the fund or are contributions being made on their behalf? This will cover personal contributions, employer contributions, spouse contributions, government cocontributions and also superannuation rollovers from an external super fund into the SMSF.

If a member is an active member, you then need to determine if they are a resident member or not as you need at least 50 per cent of the accumulated benefits in the SMSF to belong to resident active members.

Again, this is an issue that can potentially arise when you have clients who are moving overseas and cease to be Australian residents for a period of time. If they are deemed to be a contributing member during the time of absence and are no longer Australian residents, they would likely fail this third test and the SMSF could no longer satisfy the requirements to be a resident Australian super fund.

There is a solution to this if the members wish to retain the SMSF for their future return, assuming the other two tests continue to be met, and that is to ensure all contributions while the member is a non-resident are made to a different fund, for example, an Australian Prudential Regulation Authority (APRA)regulated fund. This is because:

• the issue about being a non-resident active member depends on being a contributor to the fund in question – in this case the SMSF. Therefore if they aren’t contributing to the fund, it will not have adverse consequences under this third test for the SMSF, and

• while the member would still be regarded as a non-resident contributing member to the APRA-regulated fund, given the expected size and member numbers of the public offer fund in question, it would be very unlikely the 50 per cent threshold would be of concern.

Again, the previous coalition government had proposed an amendment to this third test also, which was to remove the active member test requirements completely, which would allow the SMSF to continue to receive contributions from and in respect of nonresident members. Coupled together with the proposed extension of the temporary absence provision to five years, this would allow many SMSFs with members temporarily overseas to retain and use their funds for building their retirement benefits. The current government is committed to enacting this reform, but as mentioned previously, we are yet to see the amending legislation introduced.

So why does residency matter?

These tests, and passing them, is important as the consequence of an SMSF losing its status as a resident Australian superannuation fund can be significant. In effect the fund will cease to be a complying superannuation fund and the following consequences will arise:

1. In the year the fund loses its complying status, the assessable income of the fund will include the entire value of the fund’s assets at the start of the income year, less any non-concessional contributions or a crystallised undeducted component. The net amount is then taxed at the highest marginal tax rate.

2. Going forward, any earnings in the fund will be taxed at the highest marginal tax rate rather than the 15 per cent concessional rate.

3. Withdrawals by members in retirement will be subject to taxation rather than retaining existing tax-free status if the member is over 60 years of age.

4. These impacts apply at the fund level and not just in respect of members who have gone overseas. Any members who remain in the SMSF and have remained in Australia will also suffer these impacts to their accumulated benefits.

Most SMSFs will not have an issue around the resident Australian superannuation fund requirement. But where an adviser has SMSF clients who are contemplating going overseas, even for a short period of time, it’s important to be aware of these potential consequences and ensure plans are in place to minimise their impact.