Ensuring an SMSF never fails the residency tests
Implementing strategies to ensure an SMSF complies with the residency test is vital for your clients, as failure to meet this test can result in some significant consequences.
The technical aspect – how do SIS and ITAA interact?
To be a complying super fund in relation to a year of income, Section 42 of SISA provides that the fund must, among other things, be a 'resident-regulated superannuation fund' at all times.
Section 10 of SISA defines 'resident-regulated superannuation fund' as a regulated superannuation fund that is an Australian superannuation fund within the meaning of the ITAA 1997.
The definition of 'Australian superannuation tests' has three tests, which we commonly refer to as residency tests. They are covered in Subsection 295-95(2) of the ITAA 1997.
Therefore, a super fund qualifies for concessional tax treatment only if it passes residency tests in the ITAA 1997.
For income tax purposes, provided that a fund satisfies the definition of 'Australian superannuation fund' in subsection 295-95(2) at any time during an income year, it will be an Australian superannuation fund for the income year in which that time occurs. Only when a fund satisfies the definition of 'Australian superannuation fund' at all times, it is a complying fund within the meaning of SIS.
The three tests that must be met for an SMSF to maintain its residency status are:
- the fund was established in Australia, or any asset of the fund is situated in Australia at that time; and
- at that time, the central management and control of the fund is ordinarily in Australia; and
- at that time either the fund had no active members or at least 50% of the superannuation account balance in the SMSF belongs to 'resident active members'.
The roles of accountants and auditors in reporting residency status of an SMSF
The tests above are not overly complicated so that an accountant or an auditor can identify whether a fund will meet the definition of ‘Australian superannuation fund’. In TR 2008/9 Meaning of Australian superannuation fund in subsection 295-95(2) of the Income Tax Act 1997, relevant technical terms are further clarified and different scenarios explained.
It’s worth noting that Part B of the audit report is all on SIS compliance and Section 42 (complying superannuation fund) is not part of the compliance section auditors are signing off. So technically, when an auditor notices a non-resident fund, it is not reported under Part B fund compliance on the audit report. Instead, Part A is qualified when the non-resident fund is taxed at a concessional tax rate.
Auditors will generally have the residency tests covered on the trustee representation letters. For accountants to report residency status of a fund, there is a tax return question asking whether the status of the SMSF is an Australian superannuation fund or not. The reporting is straightforward for both accountants and auditors once the facts are presented.
However, rather than identifying and reporting the status of a fund at the end of an income year, we want to be proactive and ensure a fund maintains its residency status throughout the year and fund assets are not eroded by higher tax rate due to the lack of knowledge of trustees.
How to make sure an SMSF stays as a resident fund when the members/trustees are going overseas
It’s not difficult to have preventative measures in place so that all the funds in your practice will remain compliant. Communication is key, and it’s better to communicate before or during the financial year rather than delivering the conclusion and consequence after the financial year.
I recommend sending out a questionnaire on this specific topic early in the year.
Here are some sample questions to use:
(1) Was the fund established in Australia, or were any assets of the fund situated in Australia at that time?
(2) Does any trustee intend to temporarily leave Australia for more than two years?
(3) Does any trustee intend to leave Australia and stay overseas indefinitely?
(4) Does any member intend to leave Australia during the year (become a non-resident for tax purposes)?
(5) If the answer to question (4) is 'yes', will the fund receive contributions for any members including those who are staying in Australia?
Depending on the history and the level of communication you ordinarily have with a particular client, the questionnaire can be modified.
Most funds meet the first test if they are established in Australia.
The common solutions for central management and control (CM&C) test is to examine the facts, and either have the trustees document their intention of temporary absence in the minutes of a meeting, or delegate trustee duties to an Australian resident to exercise CM&C if it’s hard to establish the departure is on a temporary basis. TR 2008/9 is a good reference point and has most of the common scenarios covered.
To pass the active member test, the most secure method is probably to arrange the members going overseas have contributions made outside of their SMSF, for example through a retail or industry super fund. They can rollover the contributions to their SMSF when they return as an Australian resident.
If the fund fails the residency tests, not only the earnings received during the financial year, but also sum of the market value of the fund’s assets just before the start of the income year, less any member contributions (where no tax deduction has been claimed), are all taxed at a flat rate of 45 per cent. It would be better to wind up the fund rather than having it taxed at this rate.
Vivian Bai, principal, Access Super Audit
For more on this topic, see 'Residency and SMSFs, the key compliance tests'