Taking control of investment decisions through a self-managed super (SMSF) fund is empowering, but also requires a great degree of personal responsibility from each trustee.
You need to have a detailed knowledge of the many facets of SMSFs as what seems like a minor mistake, could result in very costly consequences. Trustees need to understand, amongst other things, the sole purpose test and how it applies to the fund; recognise the importance of ongoing accounting and the associated reporting responsibilities; be aware of lending rules; and realise that often the costs of trustees getting professional help and advice is generally much cheaper than the penalties incurred should things go awry.
There have been many cases where financially savvy members and trustees have been caught out for not being compliant with the ATO regulations. This was highlighted in a recent case where a former bank chief executive and multi-national corporate chairman was charged by the ATO for not paying enough to meet the minimum pension standards. Because the minimum payments weren't made, income from the fund became taxable, and the SMSF was hit with a much steeper tax bill than he anticipated. As trustees they tried to argue that the ATO had incorrectly calculated the income paid out of the SMSF, asking for a $1.2 million reduction on their $2.25 million assessment. Ultimately, the case was settled out of court, but who wants to go through this trauma and expense for such a simple error?
As this case shows, relatively simple mistakes can be very costly and it is therefore imperative that before setting up an SMSF, you are confident that you are able to, or have the resources to, comply with all legal and tax obligations.
Some of the key issues that can often cause SMSF trustees problems are outlined below.
Estate planning is one of the most complicated aspects of managing a SMSF. A poorly-made estate plan can invalidate a lifetime of wealth-building and create a legal nightmare for trustees and their families. It is imperative that your SMSF is properly integrated with your Will and estate plans to potentially save a lot of money and avoid unnecessary stress for all involved in the long run.
Considering the amount of time and effort spent building wealth throughout the lifetime of an SMSF, the worst thing that could occur following the passing of a member is for their life savings to be distributed against their wishes. In a recent Netwealth webinar, Keat Chew, Head of Technical Services at Netwealth, noted that these scenarios are not uncommon. They sometimes eventuate when an SMSF is set up without a clear understanding of the terms and definitions used within the relevant bodies of law and regulations, for example, not understanding the key differences between the trustee’s duties and discretion, the interaction between the member's Will and the relevant superannuation, taxation and estate law when setting up an SMSF. Past cases have demonstrated that following the death of a member, what happens with their SMSF death benefit (as permitted by law and under the deed and the trustees discretionary powers) can be vastly different to what the deceased member would have expected and planned for.
Consider the case presented before the Supreme Court of Western Australia, Ioppolo v Conti. Augusto and Francesca Conti were individual trustees of an SMSF. Francesca died without making a binding death benefit nomination (BDBN) regarding her superannuation death benefit, however made it clear in her will that nothing held in the SMSF should go to her husband, it should only be distributed to her children.
It seems she intended that that the surviving trustee would pay her benefit to her estate which was then to be dealt with by her will. However, when she died, Augusto as the surviving trustee, under the rules of the SMSF trust deed, appointed a corporate trustee, took sole control for the fund as a director of the corporate trustee and exercised his trustee discretion to pay all her death benefit to himself. Ultimately, he could by-pass her will and the children missed out on the funds.
Francesca had not realised that even though she appointed her children as executors of her estate, the estate was a legally separate entity to the super fund with the SMSF controlled by the trustee, not by her executors. Her children took the matter to court, and while it was upheld that they did have the right to be appointed as co-trustees of the SMSF, there was legal imperative that made this mandatory. Augusto, therefore, as the remaining trustee had full discretion over the fund, regardless of Francesca’s expressed intentions in her Will.
If an SMSF member intends to move overseas, great caution should be taken with the on-going management of the SMSF. This is because any super fund must be an Australian super fund to be eligible for very attractive super tax concessions and benefits.
SMSFs and member data is carefully scrutinised by the Australian Taxation Office (ATO) and members considering moving overseas (and therefore trustees of such SMSFs) need to be aware of the three tests the ATO will apply to determine whether it is an Australian super fund. Briefly, they are as follows:
- The fund must be established in Australia, or one of its assets is in Australia.
- The central management and control test demands high level strategic (trustee rather than administrative and accounting) decisions for the fund are be made in Australia. There is a provision for members to make decisions if temporarily overseas for up to two years, however even with this, extreme care is needed to ensure that the absence even if under 2 years, is still temporary. The ATO has issued very strict guidelines on what is "temporarily" overseas so it is usually imperative that members and trustees seek professional legal assistance to ensure that this test is not breached.
- The fund must have either no active members (members making contributions) or the active members in the fund who hold at least 50% of the fund’s total market value, or sum payable to members if they left the fund, must be Australian residents.
These test must be met at all times throughout the year. The penalties for failing any one of these tests are high. You could lose up to half of the fund’s assets and the assessable income will be taxed at the highest marginal tax rate.
There are ways to avoid this outcome if you do move overseas. Trustee's can set up an enduring power of attorney (EPOA) based in Australia. This means the trustees moving overseas should resign and the SMSF EPOA will take over total control of the fund. However, the original trustees will lose their direct control over their SMSF so they will need confidence in whomever is appointed as EPOA. Active members with over 50% of the fund can also cease contributions, although this can be complicated by an overseas employer making contributions, causing the test to fail.
One simple and safe solution is to wind up the SMSF and rollover to a retail super fund. By their very nature, a retail fund should always meet the three tests. In turn, this means that the member who has moved overseas can continue to make the investment decisions, make contribution and effectively control their own super outcomes.
Limited recourse borrowing arrangements (LRBAs), which allow super fund trustee's to borrow to purchase an asset in the fund, present numerous opportunities for SMSF members. They allow the purchase of high value assets such as real property without triggering contribution caps.
LBRAs, however, can introduce several complex issues. For example, establishing the holding trust correctly; understanding that the contract and documentation varies from state to state; stamp duty issues; cash flow requirements to fund the debt; and legislative guidelines and reporting, to name a few.
Some trustees also don’t recognise that an LRBAs must be maintained for only a single asset. For example, undertaking a strata title and subdividing a block of land would breach the LRBA guidelines possibly triggering unexpected stamp duty, tax consequences and costs.
Understanding the many nuances of an SMSF and making the best choice for you and your client
SMSFs are extremely complex in nature and if they are not carefully planned from the outset, some decisions have the potential to invalidate a lifetime of wealth-building and create a legal nightmare for trustees, members and their families. As Chew highlighted many times through his webinar, getting professional specialist advice is the best way to help ensure an SMSF is fully compliant and will help avoid any unwanted scrutiny, unplanned tax obligations and potential fines.