Increasing legal complexity requires greater preparation for SMSF super splitting

Speaking on a recent DBA Lawyers podcast, senior associate William Fettes said that due to the increasing complexity of the super splitting rules, it is recommended that SMSFs be better prepared when navigating what options are feasible under the rules and how best to structure a proposed split from a superannuation law and tax perspective.

“It’s, unfortunately, one of those areas where it’s just so technical,” Mr Fettes said.

“Even after working in this area and doing a lot of work in this area, we see landmines all the time. Things like precedence being used where it’s been drafted as either a court order, but it’s then been using a financial agreement precedent, also using wrong references to the Family Law Act and vice versa.

“We see things where the splitting order doesn’t actually contemplate the split it needs to achieve. For example, things like it’s intended that the wife get gets X dollars, but they haven’t given thought to the fact that the way they’ve drafted the split could actually result in it in a negative value because they’ve created a formula that doesn’t work.

“They haven’t taken into account the wife’s own superannuation entitlement, so they’ve only thought of it as a split from the husband to the wife, and it doesn’t actually achieve the intended outcome.”

Mr Fettes said there are all kinds of ways that these things can go wrong during the super split, and it’s very hard to then remedy that without remedial work needing to be done.

“It is something that can’t be rushed and done in a half-clock way because it’s just an incredibly technical area of the law and it’s quite strategic in how it’s drafted and you just need to be respectful of that complexity,” he noted.

Mr Fettes reiterated there are superannuation compliance issues specific to SMSFs to be on the lookout for, noting that these have become inordinately more complex.

“If you have funds that have very bad compliance issues, even for a simple fund that is clearly complying and has no compliance issues, you know it’s complex and getting it done right is an exercise that requires care, skill and attention,” he said.

“But a fund that is significantly behind on its annual returns or has major compliance issues, loans to members and in-house asset problems — all this sort of stuff makes it so much harder because the fund probably needs to be re-regularised, there may need to be disclosures to the ATO.

“The problem is when the directors of the trustee or the individual trustees aren’t talking. How do you sort through and try and re-regularise that fund when both parties are exposed to the compliance problems and they don’t really want to co-operate?”

Mr Fettes added it’s an incredibly fraught process for lawyers whenever there is a family law matter with compliance problems. 

“The law doesn’t respect the passive trustee idea, for example, where a spouse was running this fund and they had control of everything and they did XYZ and the client had no knowledge of it,” he continued.

“Unfortunately, our system of administrative penalties and being made non-complying and even trustee disqualification doesn’t really respect the idea that you were just entitled to be a passive operator. So, you know you’re really on the hook for what’s happened as an individual trustee or director of a corporate trustee of an SMSF.”

When considering the process for these super split orders and what happens after the orders are put in place, Mr Fettes urged advisers to remember to follow the process set by the regulation.

“I mentioned Division 7.85 of the SIS regulations and this is where we do need to see the machinery provisions in the SIS regulations enlivened,” he said.

“Sometimes where advisers go wrong or they’re just not aware is that the orders don’t sort of self-execute and implement the split. 

“You need to have notice given to the trustee of the split and the orders and you need to then have an exchange of notices about the fact that this member’s interest is subject to a split, then the non-member spouse needs to be involved in the process of agreeing to what happens with the split amount.

“On the outset, there are broadly three common ways that you go, which is to allocate to an interest within the super fund, to transfer or roll over that amount to a nominated fund or to pay an amount as a lump sum if a relevant condition of release is satisfied.

“The non-member spouse actually needs to sign notices to the trustee and then to notify both members of all this going on. So, there’s a big flurry of paper that needs to be exchanged after the orders are in place, and that’s really important because it’s actually an operating standard under the SIS regulations that those notices are exchanged.

“It’ll actually be a breach of the operating standards if these notices aren’t exchanged. It is a commonly overlooked step in the process and it’s one where it needs preparation for the sort of various notices and elections that need to happen to make sure the split is documented fully in accordance with super law which is very important if you don’t want to be contravening the operating standards.”