The remaining measure

The 2021/22 budget put forward proposed changes to the defining conditions for an Australian super fund, but to date no further action has been taken regarding the issue. Smarter SMSF education and technical manager Tim Miller revisits the situation.

Recent ATO establishment statistics indicate a continued popularity and growth within the SMSF market, particularly among younger superannuants. How much more popular would SMSFs become if the government finally put to bed the last of the SMSF legacy items – amendments to the definition of an Australian superannuation fund to make it easier for members to contribute and run their fund while overseas.

Left hanging

In May 2021, the federal government delivered the 2021/22 budget and included two measures specifically targeted towards SMSFs. The first was the introduction of a legacy pension amnesty to allow existing SMSF members with certain types of these income streams to exit them during a defined amnesty period. It took some time, but Canberra finally delivered on that measure, and it delivered a much better outcome than was proposed back in 2021.

Measure two was to provide greater flexibility for SMSF members by removing the active member test from the definition of an Australian superannuation fund and extending the central management and control test for a temporary absence of two years to five years. This proposal was not expressed as a revenue-based measure, but rather an equalitybased one to ensure members of an SMSF or a small Australian Prudential Regulation Authority (APRA) fund were extended the same opportunity as members of public offer funds, particularly with reference to making contributions. No additional progress was made during that parliamentary term, but successive governments made a further commitment to pick up this measure. However, we’ve had nothing since.

Interestingly, this wasn’t the first time the removal of the active member test had been mooted. In 2007, the Parliamentary Joint Committee on Corporations and Financial Services delivered a report following its inquiry into the structure and operation of the superannuation industry, with one of its recommendations being the removal of the active member test. I know this because it was my submission and subsequent meeting with the chair of the committee that led to the inclusion of the recommendation. Unfortunately, that report was delivered immediately prior to the 2007 federal election and a change in government saw a diminished appetite to review the recommendations.

SMSFs and travelling members

There will always be a significant number of SMSF trustees/members, both actual and potential, travelling at any given time. The definition of an Australian superannuation fund can be a complex issue for SMSFs with members abroad, but members must stay on top of their trustee obligations, including whether they have the capacity to act as trustee.

Based on the current definition of an Australian super fund, there are a number of issues trustees of an SMSF must take into consideration if they plan on travelling abroad and the consequences for getting it wrong can be dire.

Australian superannuation fund

For an SMSF to be entitled to the taxation concessions afforded to retirement savings vehicles, it must meet the definition of being an Australian superannuation fund. Taxation Ruling (TR) 2008/09 provides a great source of information on the residency issues for SMSFs and expands the definition of what constitutes an Australian super fund, providing further clarity for trustees and advisers on the three tests needing to be addressed to determine whether an SMSF satisfies that definition.

Test 1 – Fund establishment and fund assets

The first test refers to the fund being established in Australia or the assets of the fund being held there. While it is generally accepted the majority of funds satisfy this test, the ATO has provided further clarity on when a fund is considered to have been established.

To establish a fund a trust deed must be executed. In addition, either a cash or inspecie contribution must be received by the fund, including rollovers. For the purposes of when a fund is established the ATO is only concerned with the contribution and this must be “paid to and accepted by the trustees in Australia”. The execution of the deed does not need to occur in Australia. If a fund satisfies this first test, it will satisfy it for all time.

Test 2 – Central management and control

The second test relates to the central management and control of the fund. Here the SMSF must ensure the central management and control is ordinarily in Australia. TR 2008/9 focuses on what constitutes central management and control, who exercises it, when are they doing it and where are they located at the time. It also defines the terms ‘ordinarily’ and ‘temporary absence’.

Central management and control relates to the strategic and high-level decision-making processes and activities of the fund, such as:

• formulating the investment strategy,

• reviewing, updating or varying the investment strategy, as well as monitoring and reviewing the performance of the fund’s investments,

• the formulation of a strategy for the prudential management of any reserves, and

• determining how the assets are to be used to fund member benefits.

According to the ATO, day-to-day operations of the fund are not considered part of the central management and control as they are regarded as being administrative in nature. Operational activities include, but are not limited to, acceptance of contributions, payment of benefits and purchasing or redeeming fund investments.

In the ruling, the regulator has expanded on the definition of central management and control being ordinarily in Australia. It has determined there must be some continuity or permanence about where the management and control is exercised to satisfy the ‘ordinarily’ requirement. The ATO will look at the facts to see if the central management and control is usually, regularly or customarily exercised in Australia.

Two-year absence – safety net, but not the only rule

The legislation states the central management and control is ordinarily in Australia even if it is temporarily outside the country for not more than two years. This provides a safety net, particularly for SMSFs, giving them comfort that if their temporary absence is for a period not exceeding two years, then they will not fail the test. The ruling expands the definition of ‘temporarily’ and establishes that the nature, rather than the time, is the main factor when determining whether the absence is indeed temporary. A fund can still satisfy the test if the duration is defined in advance or is related to the fulfillment of a specific, passing purpose such as an overseas employment contract.

Test 3 – Active member test

The active member test is the third test. A fund with no active members need only satisfy the first two tests. Retired members in receipt of a pension who do not intend or have the capability to contribute will satisfy the active member test. Of course, the extension of the contribution age to 75 provides greater scope for people to contribute for longer without any relation to work.

An active member is one who is a contributor to the fund at the particular time or on whose behalf another person has made a contribution.

To satisfy the active member test, at least 50 per cent of the assets must be held by active members who are Australian residents. Alternatively, at least 50 per cent of the sum of the amounts that would be payable to or in respect of active members if they voluntarily ceased to be members is attributable to members who are Australian residents.

For the purposes of this definition, contributions include rollovers. Interestingly, there was a decision made by the ATO in a private case in 2011 concluding a rollover did not result in the individuals involved becoming active members at the point in time it was received because it had been received by a fund when the two members were residing overseas and related to contributions made to another fund when the members were Australian residents. Given the timeframe involved and the lack of detail provided in that case, it would be appropriate to seek advice if contemplating making a rollover while overseas.

Overseas travel – length and intention

As stated above, part of the definition of an Australian superannuation fund is its central management and control is ordinarily in Australia, requiring the high-level strategic decisions of an SMSF be made while the trustees are in Australia or are made while the trustees are temporarily outside of Australia for a period no longer than two years.

As such, an open-ended overseas holiday may not satisfy the requirements as the trustees’ intention may be to return, but the period of absence is not defined in advance.

In the instance of overseas travel, it is necessary for the trustees to determine upfront what their intentions are as they may be required to make alternative arrangements prior to their departure.

A fund with equal trustee representation in Australia and overseas would satisfy the ATO’s requirements that the control of the fund is in Australia, therefore a mum and dad SMSF with two Australian resident children as members and trustees would meet its obligations of being an Australian superannuation fund.

A fund that doesn’t have an equal number of trustees in Australia as overseas, or no Australian-domiciled trustee, will need to look at alternative arrangements. Rather than winding up or converting to a small APRA fund, an alternative could be for at least 50 per cent of the travelling trustees to resign and appoint an Australian resident who holds an enduring power of attorney on their behalf to replace them as trustee. This arrangement would result in the appointed person(s) having the same trustee power afforded to the member if they were trustee, so the decision must not be taken lightly.

Of note there are many private binding rulings available on the ATO’s website offering different examples of where the regulator is satisfied that the central management and control remains in Australia when a person’s absence exceeds two years. There are also examples of appointing other parties.

Consequence of getting it wrong

If an SMSF fails the Australian superannuation fund definition, it will not be considered a resident-regulated super fund at all times during the year and will be non-complying for tax purposes, forgoing the tax concessions otherwise afforded. The tax rate applicable to a non-complying super fund is 45 per cent on its assessable income. In the first year, the assessable income extends beyond the ordinary income to include the assets of the fund less any tax-free component. That’s quite a sting.

The only time the ATO has officially offered relief to this tax was during the COVID-19 pandemic.

Conclusion

The current definition of an Australian superannuation fund substantially disadvantages SMSFs. Based on the rhetoric of Treasury over the past few years, they want super to be an even playing field. Removing the active member test would go a long way to providing equality to all contributors. Changing the central management and control temporary absence rule from two to five years would provide practical relief, but to date that hasn’t been the bigger issue.