Splitting documents should not be overlooked
Many advisers are unaware that Splitting Orders in respect of an SMSF are not self-executing and must broadly be implemented following the steps set out in accordance with the relevant criteria and documents required by the SISR.
Where a relationship breakdown has occurred between spouses, the parties’ superannuation entitlements may be subject to an overall family law property settlement. Typically, this involves one spouse agreeing to or otherwise being required to give up some of their superannuation benefits in favour of the other spouse based on appropriately drafted orders or financial agreements.
For ease of expression, we refer to the term “Splitting Order” to include a split under a court order, a split pursuant to consent orders arrived at by the parties to family law proceedings and also to a split in accordance with a binding financial agreement.
Many advisers incorrectly assume that having Splitting Orders in place will broadly conclude the split from a legal and superannuation perspective. However, this is not the case, and advisers need to be aware of the additional steps required under the Superannuation Industry (Supervision) Act 1993 (Cth) (SISA) and the Superannuation Industry (Supervision) Regulations 1994 (Cth) (SISR) to ensure their clients are not exposed to penalties and other negative consequences.
This article examines the legal mechanics of properly implementing a superannuation split in an SMSF, with a particular focus on what must occur after Splitting Orders have been obtained.
Who are the parties in a split?
As a preliminary matter, it is important to clarify a point on terminology. The superannuation splitting laws refer to the relevant parties as the member spouse (MS) and non-member spouse (NMS) which can be confusing to a layperson.
The key point to remember about this terminology is that the MS is the party whose superannuation interest is subject to a split (i.e. they are the party giving up their super in relation to a particular split). In contrast, the member who receives the benefit of the split is referred to as the NMS.
Though it is often the case that a NMS will depart the fund after the split is carried out, the terminology of “non-member” and “member” is not based on membership status in the SMSF. Indeed, it is possible to have a MS departing the fund and a NMS remaining in the fund.
Note also that if there is a split of each member’s interest in the same SMSF, both parties may be a MS in respect of their own interest and NMS in respect of their former spouse’s interest (e.g. where a cross split is being implemented).
The usual pathway for a split in an SMSF
As noted above, Splitting Orders must be implemented with regard to the additional steps set out in the SISA and the SISR. We set out below the major steps that must be implemented once Splitting Orders are in place.
(NB: This article outlines the key steps required in relation to the usual situation for an SMSF which is a split implemented under Div 7A.2 of the SISR initiated by the NMS. We do not consider the trustee-initiated pathway in Div 7A.1A of the SISR for implementing a split as this is far less common in an SMSF context.)
Step 1: The NMS must provide the SMSF trustee with a copy of the Splitting Orders together with a notice under reg 72 of the Family Law (Superannuation) Regulations 2001 (Cth) regarding the split in their favour. The notice must include the contact details for the NMS.
Step 2: The SMSF trustee must give each party a “payment split notice” to formally notify the parties that the interest of the MS is subject to a split under the terms of the Splitting Order.
In addition to the payment split notice, the SMSF trustee must at this time give the NMS a notice under reg 2.36C of the SISR setting out the particulars of the split and certain other key information.
Step 3: Subject to the governing rules of the fund, and the requirements of the Splitting Order, the NMS must make a choice regarding how the split amount is to be treated and notify the SMSF trustee of that choice. In broad terms, the choices available to the NMS are as follows:
Option 1: Allocation to a new interest in the SMSF unless the fund deed precludes this.
Option 2: Transfer or rollover of the amount under the Splitting Order to the NMS’s nominated superannuation fund.
Option 3: Payment of a lump sum. This is available only where the amount being paid out to the NMS constitutes unrestricted non-preserved benefits split from the MS or where the member has met a relevant condition of release and therefore has unrestricted non-preserved benefits.
Note: The choice by the NMS must be exercised within 28 days from the payment split notice or such longer period as the trustee allows.
Naturally, sharing an SMSF after a relationship breakdown is not advisable. Therefore, Option 1 is not commonly implemented unless it is part of preparatory work for one of the members to exit the SMSF.
Where a condition of release has not been satisfied, Option 2 is the usual option that is chosen — i.e. the split amount (known as “transferable benefits” in this context) is rolled over to another fund, such as a new SMSF or a large public offer superannuation fund.
Step 4: Once Steps 1–3 are carried out, the SMSF trustee is broadly obliged to give effect to the choice of the NMS, subject to the governing rules of the fund and the Splitting Orders. The SMSF trustee must then calculate the amount to be transferred (see the commentary below regarding relevant base amount adjustments), determine the tax components and the preservation components, and notify each of the parties regarding the split being implemented.
Step 5: After completion of the allocation to the NMS, a rollover is prepared using the prescribed ATO forms if relevant (i.e. pursuant to Option 2 under Step 3).
Note that the rollover may also need to include the departing member’s own superannuation entitlement where relevant.
Also, the fund’s records must be appropriately updated and relevant trustee resolutions prepared.
Base amount adjustment
If the Splitting Orders specify a base amount split, the base amount must be adjusted from the operative time until the date of transfer of the transferable benefits (see the definition of transferable benefits in reg 1.03 of the SISR) by interest being calculated and added for the relevant period at the prescribed annual interest rate.
Failure to implement documents under Div 7A.2 of the SISR
As noted above, Splitting Orders are not self-executing and do not cover the additional obligations that apply to a super split under the SISA and the SISR.
The giving of the various notices in relation to a Div 7A.2 split noted under Steps 1–4 above is an operating standard for regulated superannuation funds under reg 7A.02 of the SISR. Thus, failure to give these notices will result in one or more contraventions of s 34(1) of the SISA, with each contravention attracting an administrative penalty equal to 20 penalty units.
The value of a penalty unit is currently $222. Accordingly, failure to implement appropriate Div 7A.2 documents after Splitting Orders are obtained will result in each individual trustee of an SMSF being liable (on a strict liability basis) for $4,440 per contravention.
If the fund has a corporate trustee, each director will be jointly and severally liable for a $4,440 penalty.
Additionally, the failure to implement appropriate splitting implementation documents under the SISR may result in further negative consequences including:
- the other side seeking to reopen Splitting Orders and property settlements etc; and
- claims being brought against advisers who were involved in the process, e.g. if the adviser gave no consideration to the SISR documents required to implement a split.
Unfortunately, many advisers, including experienced family law practitioners, are not fully aware of the SISR criteria, and thus, they may not point out these aspects to their clients or the client’s other advisers (such as accountants and financial planners) who may also be involved with a split. In recent times, however, we are seeing SMSF auditors becoming more aware and detecting and reporting contraventions in relation to these compliance requirements in their auditor contravention reports which may result in more accountants and financial planners becoming aware of the SISR requirements.
Many advisers are unaware that Splitting Orders in respect of an SMSF are not self-executing and must broadly be implemented following the steps set out above in accordance with the relevant criteria and documents required by the SISR.
Accordingly, to ensure that clients are not exposed to significant penalties and further negative risks, it is critical that advisers obtain appropriate advice regarding the proper process to follow so that the various notices and other steps are followed in accordance with the operating standards in the SISA and the SISR.
Note that the commentary in this article is a general summary only and is not intended to be relied on as legal advice.
William Fettes, senior associate, and Daniel Butler, director, DBA Lawyers