SMSFs warned on compliance traps facing transactions with former spouse

Some of the compliance considerations would be relevant in situations where the transacting party is a distant relative (i.e. cousin) or a friend who isn’t included in the definition of “relative” under the Superannuation Industry (Supervision) Act 1993 (Cth) (the SIS Act).

Mr Song said it is important to note the definition of relative and general prohibition on lending money of the fund or otherwise giving financial assistance to a member’s relative.

“The SIS Act contains two slightly different definitions of a ‘relative’ — one in s10 and the other in s17A. The definition in s17A adopts a wider definition which includes ‘former spouse’ (and cousins) as a relative, but this definition is not relevant for the purpose of determining if there is any prohibited loan or financial assistance to a member’s relative under s65 of the SIS Act,” he said.

“The relevant definition is in s10, and it doesn’t include a former spouse as a relative of the member. On the face of it then, there is no general prohibition on the fund trustee from lending money or giving financial assistance to the member’s former spouse.”

However, Mr Song said that care needs to be taken to ensure that the transaction doesn’t give rise to an “indirect” financial assistance to someone who is a relative (i.e. the member’s children). 

“The ATO’s view as expressed in SMSFR 2008/1 is that the s65(2)(b) also encompasses any arrangement where the loan is to a non-relative but indirectly gives financial assistance to a member’s relative,” he said.

“If the arrangement is with mutual understanding that the monies so borrowed from the fund would be used for the benefit of their children (or any other relatives of the member), arguably, there is provision of prohibited indirect financial assistance.

“This risk could be mitigated by entering into (and adhering to the terms of) an enforceable agreement that is appropriately drafted to restrict the use of loan amount by the borrower and otherwise note reasonable arm’s-length terms between the parties.”

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Whether a former spouse of a member is a related party of the fund is not necessarily a simple question. Mr Song noted that the SIS Act adopts a broad definition of related party and can quite easily capture a member’s ex-spouse as a related party.

An example is where the member’s superannuation interest is subject to a payment split in favour of their former spouse pursuant to a Family Law consent order. 

“Even where the former spouse has never had a membership interest themselves (and regardless of what the trust deed or the member register of the fund says), the SIS Act and the regulations extend the definition of a member for SMSFs and deem the former spouse themselves as a member of the fund from the operative time of the splitting order,” Mr Song noted.

“To avoid this situation, it is necessary to convert the former spouse’s ‘entitlement’ under the court order (or financial agreement) into a ‘superannuation interest’ for the former spouse in another superannuation fund (rollover) or cashing out the benefits to the former spouse if he/she has met an unrestricted condition of release.

“This example highlights the importance of seeking the appropriate advice and to carefully complete the super splitting process right to the end. A Family Court order is a powerful document and it might offer a false sense of comfort that the process is over.”

Another example is where the former spouse is considered a related party due to being a partner of a partnership with the member, according to Mr Song. This is because the SIS Act has adopted the tax law definition of partnership for IHA purposes which is broader than the general law definition of a partnership. 

This broader definition includes arrangements whereby two or more individuals or entities are simply in receipt of income jointly. 

“Likely the Family Law consent order would have considered and dealt with any joint investment. However, it’s again important to ensure that the parties have actually implemented the orders and no longer hold any joint investment,” Mr Song explained.

“For example, if an order required a jointly owned investment property to be transferred to one of them, the transfer should be effected with a conveyancer to ensure they are not considered as related parties by reason of jointly receiving investment income.

“There are, of course, many other circumstances where a former spouse could be considered a related party of the fund including via general law partnership or involvement in the same company or a trust.  

“Any transactions would, of course, be subject to the sole purpose test and the investment strategy requirement. Trustees should not assume that a member’s ex-spouse or other non-relatives such as distant family members or friends are not related parties of the fund but should seek professional advice when considering any transactions with any of them.”