Mastering SMSF succession strategies
A comprehensive look at strategies that can significantly bolster your client’s position and set the foundation for SMSF succession.
There are many strategies put forward on how to provide smooth and effective succession for SMSF members. Fortunately, while there is no ‘one size fits all’ solution, there are a number of strategies that are simple and cost effective that can set the foundation for SMSF succession.
Sole purpose corporate trustee
We strongly recommend that an SMSF have a sole purpose corporate trustee rather than individuals as this greatly enhances succession. The up-front cost of establishing the company generally give long-term benefits that far outweigh the upfront cost.
Still, around 74% of SMSFs still have individual trustees. This is surprising considering the many long-term advantages from having a corporate trustee.
The introduction of the new administrative penalty regime in mid-2014 can now result in an administrative penalty ranging from $850 to $10,200 for each contravention. Importantly here, the penalties are imposed on a per head basis for individual trustees. In contrast, the directors of a company are only jointly liable to one penalty per contravention. Thus, if an SMSF loan is made to a member or related party, and there are two individual trustees, the minimum penalty is $20,400 (compared to $10,200 for an SMSF with a corporate trustee). Loans to members/related parties are consistently noted year after year by the ATO as one of the main contraventions in the 15,000 to 18,000 auditor contravention reports lodged with the ATO each year. Thus, for many SMSFs, it is not so much a question of not being subject to one of these penalties but is merely a question of when. In my view, this new penalty regime is the ‘nail in the coffin’ for SMSFs with individual trustees.
Moreover, when you consider various legal cases, the merits of having a corporate trustee become very clear. In Katz v Grossman  NSWSC 934 a family relationship between two children (Linda and Daniel) was jeopardised as a result of Linda being admitted as a co-trustee on her mother’s (Evelin Katz) death to satisfy the SMSF trustee-member rules. Linda used this power on her father’s (Ervin Katz) subsequent death to pay herself approximately $1.2 million of his death benefit.
Ervin and Evelin were the original trustees/members of their SMSF. After Evelin’s death, Ervin appointed his daughter Linda as the other co-trustee. Shortly after Ervin’s death, Linda appointed her husband (Peter Grossman) as co-trustee and refused to follow her late father’s non-binding nomination (an equal sharing between her and her brother Daniel).
This case could have easily been avoided if a corporate trustee had been appointed with Ervin gifting an equal number of shares (in the corporate trustee) to each child via his will. In addition, Ervin could have left a binding death benefit nomination (‘BDBN’) paying his death benefit to his deceased estate (ie, his executor as legal personal representative (‘LPR’)).
With so many SMSFs with individual trustees currently managed by mums and dads with children who are waiting in line for succession, Katz v Grossman is a great ‘war’ story to discuss to encourage families to commence their SMSF succession planning.
Thus, in summary, a corporate trustee is an essential step in the process of SMSF succession planning.
Why is succession to control so important?
Many lawyers swear by the old saying that possession is 9/10ths of the law. This general expression reflects the fact that even if you do have legal rights, having to enforce these rights causes great expense, time delay and uncertainty. In many legal battles, many give up soon after receiving a number of invoices from their lawyers, unless they are seeing some tangible progress. Entering the steps of a Supreme Court typically involves a substantial outlay.
The recent decision of Wooster v Morris  VSC 594 is the most important decision ever regarding SMSF succession planning. Namely, what really matters in SMSF succession planning is the identity of who controls the fund on loss of capacity or death.
Mr Morris (‘the deceased’) had two adult daughters from a previous marriage (Mrs Wooster and Mrs Smoel; being the plaintiffs). He also had a second wife, Mrs Morris. The deceased and Mrs Morris were the members and trustees of the SMSF. The deceased made a BDBN in favour of his two daughters.
After his death, Mrs Morris appointed herself as the sole director/shareholder of a corporate trustee. She decided the BDBN (in favour of Mr Morris’ two daughters) was not binding and, as sole director of the corporate trustee, decided to pay herself the $924,509 death benefit.
The plaintiffs issued court proceedings seeking declarations that the BDBN was binding. A ‘special referee’ found in favour of the plaintiffs, holding the BDBN binding and that the plaintiffs were entitled to be paid the death benefit plus interest. (The parties agreed to be bound by the referee’s findings.) A further legal battle over what amounts were available to be paid as a deceased member’s death benefit meant that the case then ended up in the Supreme Court. The main lessons from this case are summarised below.
Lesson 1 — LPR does not automatically become a trustee
Wooster v Morris clearly dispels the myth that when a person dies their executors (LPRs) automatically become a trustee in the deceased’s place. Here, the plaintiffs were the deceased’s executors but they did not become trustees. This point was also confirmed in Ioppolo & Hesford v Conti  WASC 389 where the deceased member’s two executor-children were unsuccessful in their case against their mother’s second spouse to be appointed as SMSF trustees following their mother’s death.
The identity of trustee on death is ultimately determined by the SMSF deed. Unfortunately, there are very few SMSF deeds that appropriately distribute the power to appoint a trustee upon death or loss of capacity. I will return to this point later.
Lesson 2 — BDBNs are only a partial solution at best
There is a misconception that SMSF succession planning is handled by making a BDBN. Wooster v Morris clearly dispels this myth as well. In Wooster v Morris the deceased had made a BDBN but the plaintiffs still had to spend years in legal battles to obtain any money. While a BDBN can be important, it will not necessarily be complied with. However, there is a much greater opportunity for a BDBN to be effective if an intended successor can, in essence, ‘stand in the shoes’ of the deceased to ensure that the control of the fund is not simply left to the surviving member(s). Accordingly, while a BDBN can be an important tool in SMSF succession planning, the ‘control’ if the fund is more crucial.
Lesson 3 — what really matters is who controls the fund
Wooster v Morris clearly demonstrates that far more important than a BDBN is the identity of who controls the fund on a member’s death or loss of capacity. As stated above, this depends to a very large degree on what the SMSF deed. In Wooster v Morris the trustee’s legal fees in defending the claim were $302,699 in one year as reflected in the fund’s 2013 accounts.
Thus, it is crucial that SMSF trustees and members plan succession to the trustee role to cover loss of capacity and death.
How to plan for control of an SMSF with a corporate trustee
One key planning strategy for covering risks on loss of capacity or death is to have a trusted person ‘stand in your shoes’ as your successor director. This requires planning in advance to ensure the smooth transition to an SMSF. To ensure that this occurs, amongst other things, the following matters needs to be considered:
• Whether the use of successor director is appropriate and, if so whether the constitution of the corporate trustee company allows for successor directors at all. Most constitutions (especially older ones) will not have mechanisms for successor directors.
• The identity of the person who is to become a successor director. One must ensure they are willing to act and that there are sufficient instructions/wishes documented for them on what needs to be done.
• Consideration of whether the will and enduring power of attorney (‘EPoA’) nominates the appropriate person that the person wants to stand in their shoes. (Basically, an attorney under an EPoA while a person is alive and the executor of a deceased person’s will is their LPR who can act for them in legal and financial matters.) This can often impact whether fund remains a SMSF.
• Check the SMSF deed and the constitution to the corporate trustee to see what steps and documents need completing to appoint that person. Typically, in addition to that person consenting in writing, they may need to satisfy some other hurdles and better to discover these now; otherwise it may be too late.
• It is important to note that if someone has more than one LPR and they wish to nominate more than one, that the voting and decision provisions of the relevant SMSF deed and constitution should be carefully examined. This is because unless there are special provisions to equalise voting, each attorney/executor may have one vote per head. However, for the sake of fairness, the joint LPR who is standing in for the incapacitated/deceased member should only assume this (one) person’s voting capacity. Thus, if there are two attorney/executors nominated to act jointly, the joint LPRs should only have the equivalent of one vote.
• Note that in the case of a corporate trustee, the decision making depends in the first instance on what is in the constitution (and not what is in the SMSF deed even though many deeds seek to cover this). In most constitutions, directors usually have an equal vote regardless of the number of shares they hold or their account balance in the Fund. The casting or deciding vote is generally given to the chairperson of the meeting. (In a mum and dad company, this is generally inappropriate and such constitutions should be avoided.) Given that most mum and dad companies do not comply with formalities, there is generally no practical mechanism to work through potential deadlocks. One solution could be, for instance, if there is a deadlock the person with the most voting shares can have a casting vote. Again, the shares on issue or the constitution could be tailored to provide such a mechanism.
• In so checking the deed/constitution it is important to check what voting mechanism applies, eg, are decisions determined by the number of directors, member account balances, shares held in the corporate trustee or via some other method. This is important as the constitution and/or the SMSF Deed may need amending if it is not appropriate. For example, if the relevant member has the lion’s share of the fund, and voting is based on the number of directors, then this could give rise to an imbalance if the member with the greater fund balance wants control over the company’s decisions. One mechanism to work through this type of deadlock would be to give member with the greater fund balance the majority of voting shares and ensuring the constitution reflects this voting power in director and shareholder decisions. If the constitution is not appropriate, then it should be tailored accordingly.
• There are numerous advantages for using a corporate trustee compared to individuals as trustees. However, ultimately a well-designed SMSF deed is also required. In many SMSF deeds, the majority of members hire and fire the trustee. Under this type of deed, the company could be removed by a majority of members which does not reflect any member’s account balance in the fund. Thus, it is crucial that you check the mechanism for changing a trustee to ensure a smooth and planned succession occurs. For example, if you have nominated someone to become your nominated successor director, then the corporate trustee and therefore this person could be voted out soon afterwards if the SMSF deed allows the other member(s) by way of a majority vote.
• It is also important to consider who will be the successor shareholder as the shareholders generally hire and fire the directors of a company. (Thus as you can readily see from the above analysis, SMSF succession involves a review of both the SMSF deed and the constitution and these two need to be consistent in design and the implementation of the succession strategy to overcome any conflicts between them arising).
• Note, the ATO in SMSFR 2010/2 confirm that a member can nominate more than one LPR to stand in their shoes as a director. However, if there is more than one attorney/executor, your nomination should specify who has first go or you should specify whether they are to act jointly or jointly and severally. Also, a nominated person could well be disqualified if they are bankrupt or if they have ever been convicted of an offence involving dishonesty. Accordingly, one or two substitutes should also be nominated just in case.
On the death of a member, the trustee is responsible for administering the fund. On the death of a member, if the member did not make a BDBN, the decision on how to pay death benefits is generally left to the trustee’s discretion. Accordingly, in the case of a second spouse, who is left running the fund, they will have discretion as to how to manage the fund and pay out any death benefit.
Smooth and efficient SMSF succession planning requires quality documents and advice. Unless appropriate prior planning is in place, who ends up controlling your super and with your super moneys largely depends on trust and, if the trusted person is not willing to implement your wishes, then your super is subject to a great deal of uncertainty.
Daniel Butler, director, DBA Lawyers.