Trustees warned to keep sole purpose in mind to avoid possible legal action
SMSF trustees have to ensure funds are set up with a clear sole purpose or face the possibility of court challenges.
“The decisions and choices a trustee makes during the life cycle of their fund need to be clear and concise or they could end up in court,” warned Shelley Banton, head of education at ASF Audits.
She said one of the biggest challenges in SMSFs is what happens when a member dies because the choices that member made in life will continue to have consequences – some of which may negatively impact their family.
“The sole purpose test forces trustees to make decisions that are in the best interest of the members and their beneficiaries,” she said.
“It’s important to ensure the fund is set up with the end in sight, and that members need to make sure their superannuation is distributed to those whom they want it to go to without any problems.”
Ms Banton said the definition of an SMSF is an important starting point, because when a member dies, the fund must continue meeting the requirements of section 17A of the Superannuation Industry (Supervision) Act 1993 (SIS Act).
“The definition is slightly different depending on whether it’s a single-member or a multi-member fund, and then what type of structure or trustee structure it has,” she said.
Single-member funds can have an individual or a corporate trustee, she said, but in both cases, there’s only one additional trustee or a director of the corporate trustee, and they have to be a relative.
“If the trust deed stipulated that a member must complete an application form to be a member, we would also need the member application of the trustee, even though it’s not a requirement under 17A, and this is where it’s critical to read the deed,” she said.
“For multi-member funds, regardless of whether it’s an individual or a corporate trustee, each individual has to be a member of the fund as does each director of the corporate trustee.
“Some trustees may have a member balance but regardless of whether they do or don’t, we need to have a signed and dated member application form for all trustees and directors of the corporate trustee in a multi-member fund, because it’s a requirement of section 17A.
“The rule for all funds is that no member can be an employee of another member unless they’re relatives and a trustee can’t receive remuneration unless they’re working in a professional capacity, they’re fully qualified, licensed, insured and then any remuneration must be at arm’s length and on commercial terms.”
Ms Banton said that where a fund ceases to meet the definition of s17A, there are options for an SMSF to restructure such as change to a small APRA fund, wind up or restructure within six months.
“If you have a single-member fund with two individual trustees and the member dies, the fund no longer meets the definition of an SMSF but it won’t breach 17a if it restructures within six months,” she said.
“In this scenario, the fund would need to appoint another trustee who’s a relative of the existing trustee, and one of them must become a member of the fund if the existing one isn’t already.
“The alternative is that the fund can change to a corporate trustee, become a small APRA fund, or it can also wind up and roll over to an APRA fund.
“The other basic condition is that if a trustee becomes a disqualified person, they must resign immediately and they can’t have an LPR appointed for them.”
When a member dies, she said, there is a compulsory cashing requirement and the deceased member’s benefits must be cashed as soon as practicable but how soon that happens depends on a variety of issues and circumstances.
The ATO, she said, defines “as soon as practicable” as a period of six months. Any longer and the trustee should document the reasons explaining why death benefit payments were delayed.
Another important consideration is for the SMSF to determine who is considered a dependent versus who is a dependent for tax purposes.
“The SIS dependent definition means that the dependent can get the super directly out of the fund without having to go through the deceased member’s estate,” Ms Banton said. “The Tax Act, on the other hand, determines who pays the tax on the taxable components of the death benefit payment. And this is important because the tax dependents receive that death benefit tax-free.
“Typically, the death benefit gets either paid to the LPR or to a SIS dependent. If it’s to a SIS dependent it can be as a lump sum, a pension or a combination of both. But if it’s to the LPR, it has to be in the form of a lump sum and how that death benefit is then taxed depends on whether the ultimate beneficiaries are tax dependents or not at the time of the member’s death.”
“It’s also important to remember that when a death benefit is paid out as a lump sum under Regulation 6.21, It has to be cashed in the form of an interim lump sum and then a final lump sum – it can’t be done just through a journal entry,” she said.
“Illiquid assets can be taken as a lump sum as well but any change from paying out a lump sum in two instalments is going to be a breach of Regulation 6.17, so it’s important to make sure that payments are structured in this particular way.
“One of the things to remember here is that all of the death benefits have to be paid out regardless of how those payments made, because it can’t be rolled over, transferred or left in accumulation.”
An exception is that from 1 July 2017, the death benefit can be rolled over into another fund but the new fund must start a death benefit income stream or pay the amount out of super as a lump sum.
The reason is that these types of rollovers don’t lose their death benefit tax treatment and any rollovers have to be done via SuperStream, she said.