Residency and SMSFs: the key compliance tests
There are various misconceptions about how the rules around SMSF residency operate, which could be to the detriment of a client or potential client.
Consider this: a Chinese investor, Investor X, arrives in Australia, sets up an SMSF, makes the maximum allowable concessional contribution to the fund, buys a couple of properties using borrowed funds, appoints an enduring attorney and then returns to Shanghai happy in the knowledge that if the properties are held until he retires there should be no or little Australian tax on the sale proceeds.
The Australian taxpayer seems to be effectively bankrolling the retirement of a national from another country.
Is this scenario possible?
There are lots of misconceptions about how the SMSF residency requirements operate. At a recent seminar I gave, out of over 100 financial advisers who were asked to complete a 10-question quiz on the topic no-one answered all the questions accurately.
The residency of an SMSF is important because to be a complying super fund, you must be an Australian super fund as defined in s 295-95(2) of the Income Tax Assessment Act 1997 and interpreted in ATO tax ruling TR 2008/9.
A superannuation fund is an Australian superannuation fund if it meets all three of the following tests:
Test 1: the fund was established in Australia or the fund has an asset situated in Australia
Test 2: the central management and control (CM&C) of the fund is ordinarily in Australia
Test 3: the fund has no active members or at least half the fund assets or member benefits relate to active members who are Australian residents
Can Investor X’s fund meet these three tests?
Investor X can ensure the fund is set up in Australia by ensuring that the initial contribution is paid to and accepted by the trustee in Australia, regardless of where Investor X lives or where the deed is signed. But being set up in Australia is irrelevant if and when the fund simply buys Australian real estate.
CM&C are the high-level strategic actions relating to the fund, namely formulating, reviewing and varying the investment strategy; monitoring and reviewing investment performance; formulating the strategy for prudential management of reserves (if any); and determining how fund assets are used to fund member benefits.
CM&C does not include day-to-day activities like accepting contributions, investing fund assets, undertaking administrative duties or preservation and payment of member benefits.
A trustee who goes overseas can delegate CM&C, provided the delegate fulfils their role and exercises CM&C independently and without influence from the trustee.
The place where the person exercises CM&C of the fund determines the location of the CM&C of the fund regardless of where they live or are resident themselves.
A trustee can exercise CM&C from overseas while they are temporarily absent. The character of their absence is worked out by their intention at the time they leave and as a result of any subsequent changes to that intention.
The so-called two-year rule is confusing and it is better to focus on the intention of the trustee as that is paramount. That intention is measured in objective facts – there’s a list of examples in the ruling.
If a trustee/member is resident overseas they cannot meet the second part of the active member test so must meet the first part, ie. that there are no active members.
Investor X made a concessional contribution to the fund only once. If Investor X states that it his intention not to make any further contributions and no-one else can do so on his behalf he could not be considered an active member and as he is the only member, the fund therefore has no active members.
Investor X’s fund will be an Australian super fund if he either ensures that he only exercises CM&C in Australia on his regular visits here (hopefully not less than annually and preferably slightly more often) or he appoints an enduring attorney resident in Australia to exercise CM&C in the knowledge that Investor X cannot influence that attorney who must act completely independently.
Investor X needs to think carefully about what evidence he might need to show the ATO to prove either of these alternatives – air tickets, passport pages, etc.
Peter Townsend, principal, Townsends Business & Corporate Lawyers