As an important part of the Australian superannuation system to encourage saving for retirement, SMSFs are eligible for generous tax concessions. However, in order to qualify for these tax concessions an SMSF must be an Australian resident at all times during the financial year. This article will look at the current fund residency rules, the consequences of failing those rules and currently proposed changes to relax the residency requirements.
Current Residency Rules
As outlined in Section 295-95 ITAA 19971, for an SMSF to be classed as an Australian superannuation fund, and therefore benefit from the generous tax concessions, it must meet 3 conditions, at all times:
- The Fund was ‘established in Australia’, or at least one of its assets is located in Australia.
- A fund is established in Australia if its initial contribution to establish the fund was paid and accepted in Australia.
- The central management and control of the fund is ordinarily in Australia.
- The fund either has no active members or it has active members who are Australian residents who hold at least 50% of;
- the total market value of the fund’s assets attributable to superannuation interests, or
- the sum of the amounts that would be payable to active members if they decide to leave the fund.
The ATO has issued Taxation Ruling (TR) 2008/9, which sets out their interpretation of the definition of ‘Australian superannuation fund’ in subsection 295-95(2) ITAA 1997. The ruling outlines the application of the above three tests that a fund must satisfy and provides many helpful examples.
Central management and control
The central management and control (CM&C) of an SMSF must ordinarily be in Australia and relates to the core responsibilities of SMSF trustees. For example, formulating an investment strategy, monitoring performance and determining how assets should be used to pay member benefits.
However, day to day operational activities of the fund do not constitute CM&C. Such activities include the acceptance of regular contributions, the actual investment of the fund’s assets, the fulfilment of administrative duties and the preservation, payment and portability of benefits. For example, paragraph 25 of TR 2008/9 outlines that the use of an investment manager to carry out part or all of the investment management function, does not constitute CM&C. Reference can also be made to example 2, 3 & 4 in relation to what constitutes CM&C.
The location of the CM&C of the fund is determined by where the high level and strategic decisions of the fund are made. Whether it is ‘ordinarily’ in Australia at a particular time will be determined by the relevant facts and circumstances.
The CM&C can be considered to ‘ordinarily’ be in Australian where there is an equal number of individual trustees or directors of a corporate trustee located in Australia and overseas. Where each of those trustees/directors substantially and actively participate in the exercise of the CM&C of the fund, it will be accepted that the CM&C is ordinarily in Australia.
It is also possible for trustees to meet this test when SMSF trustees are outside Australia for short periods, provided they can show their absence is only temporary. Subsection 295-95(4) ITAA 1997 provides a two-year safe harbour for the CM&C where it is temporarily outside of Australia. Its effect is to provide one set of circumstances in which the CM&C of a fund will be taken to be ‘ordinarily’ in Australia. However, this provision does not restrict the meaning of ‘ordinarily’ so that the CM&C of the fund can only be temporarily outside of Australia for a period of two years or less. If the CMC&C of the fund is temporarily outside of Australia for a period of greater than two years, it can still satisfy the CM&C test if it can be shown that it is ‘ordinarily’ in Australia – refer to examples 7(a) and 8(a) of TR 2008/9.
It is also possible for trustees to formally delegate their responsibilities, for example, using the option under subsection 17A(3)(b)(ii) SIS Act to appoint a member’s attorney, under an enduring power of attorney, as trustee or director of the corporate trustee, where the attorney is residing in Australia. Refer to example 5(a) of TR 2008/9 and also SMSFR 2010/2 for the scope and operation of subsection 17A(3)(b)(ii) SIS Act.
For the purpose of the fund residency test, a fund member is an ‘active member’ if they contribute to the fund or contributions are made to the fund on their behalf during the income year. A member who does not make contributions will not be an ‘active member’, even if they may have made other transactions, like pension payments or withdrawals from their accumulation balance. For the purpose of this test, contributions include concessional, non-concessional and other contributions as well as rollovers.
A fund whose only ‘active members’ for a particular income year will be non-residents for tax purposes could consider specifically having the resident members also make contributions to try and avoid fund residency issues. Alternatively, where an SMSF member becomes a non-resident for tax purposes, they should cease any contributions from that time so that they are not counted as an ‘active member’.
Refer to examples 9, 10 & 11 of TR 2008/9.
Once aware of who the ‘active members’ of the fund are for the income year it must then be determined who are Australian tax residents and who aren’t. The primary test to determine the Australian residency status is the ‘resides test’. Some of the factors that can be used for this test include:
- Physical presence
- Intention and purpose
- Business or employment ties
- Maintenance and location of assets
- Social and living arrangements
If a member does not satisfy the ‘resides test’, they will still be an Australian tax resident if they satisfy one of the following three statutory tests:
- Domicile test
- 183-day test
- The Commonwealth superannuation test
With the knowledge of who the ‘active members’ are, and which of the ‘active members’ are Australian residents it is now possible to carry out the ‘active member’ test by comparing the balances of the ‘active members’ who are Australian residents to the total balance of all ‘active members’.
A fund which finds itself in the situation of having a non-resident member who wishes to make contributions could consider doing this outside of their SMSF, either through a retail or industry fund. Once the member returns as an Australian resident, they could then consider rolling over the contributions to their SMSF. There may also be other options available to a member in this situation, so it is a good idea for them to obtain advice about their options and maintaining the residency status of their SMSF.
While it should not be relied upon in lieu of advice and careful planning, in response to the bans, restrictions and high degree of uncertainty regarding international travel due to the impact of COVID-19, the ATO will be more lenient in regard to the application of these tests. If due to COVID-19, individual directors, or directors of a SMSFs corporate trustee are stranded overseas the ATO will not apply compliance resources to determine if the SMSF meets the relevant residency conditions.
Failing the Residency Test
Although the ATO is currently being more lenient in regard to fund residency, this is only in regard to when it is influenced by COVID-19. In all other circumstances, the SMSF failing the residency test will result in the same result as it usually would. The fund has the option to rollover its balance to a resident regulated super fund and wind up the SMSF, and if it does not do so it will be non-compliant.
An SMSF which becomes non-compliant will lose its concessional tax treatment. For the year in which the fund becomes non-complying it includes in its assessable income an amount equal to the market value of the fund’s total assets less any contributions the fund has received that are not part of the taxable income of the fund. For every year the fund remains non-complying its assessable income is continued to be taxed at the highest marginal tax rate.
A non-complying SMSF will remain so, and assessable income continues to be taxed at the highest marginal rate, until it receives a notice of compliance.
The current complying status of a fund can also be looked up on Super Fund Lookup.
Further information on non-compliance notices can be found here PS LA 2006/19.
Changes to Residency Rules
Likely as a further response to the global impact of COVID-19, on 11 May 2021 as part of the 2021/22 federal budget, the Government announced that it will relax residency requirements for SMSFs and Small APRA funds (SAF). There are two proposed changes as part of the budget.
The first change is to the safe harbour provision in relation to central management and control. As previously mentioned, the central management and control of an SMSF must ordinarily be in Australia and may be considered to be such despite the trustee(s) being temporarily outside of Australia. The proposed change is to extend the two year safe harbour rule under subsection 295-95(4) ITAA 1997 from two to five years.
The second change which has been proposed is the total removal of the ‘active member’ test.
These measures will allow SMSF and SAF members to continue to contribute to their superannuation fund whilst temporarily overseas, ensuring consistent treatment with members of large APRA-regulated funds. This will provide members the flexibility to keep and continue to contribute to their fund while undertaking overseas work and education opportunities.
These changes are to take effect from the first year after royal assent is given. This is expected to be prior to 1 July 2022 and as such commence from the 2022/23 financial year. However, these changes have yet to be enacted.
The impact on a fund which fails to meet the residency test and therefore becomes non-complying is exceptionally severe. In addition to having assessable income taxed at the highest marginal rate each year a fund is non-complying, the market value of the fund’s total assets at the start of the income year in which the fund ceased to be an ‘Australian superannuation fund’ is also taxed at the highest marginal rate that year. This seems a steep penalty when it is likely to be an unintentional breach. As such, the relaxation of these residency rules, especially in these times of uncertainty, should come as a welcome relief to SMSF members. However, it will continue to be of high importance to always consider the application and consequences of the fund residency rules where SMSF members, trustees or directors (of the corporate trustee) travel outside of Australia and to consider and address these before the relevant person(s) leave Australia.
1. Income Tax Assessment 1997
This information is provided by Accurium Pty Limited ABN 13 009 492 219 (Accurium). It is factual information only and is not intended to be financial product advice, legal advice or tax advice, and should not be relied upon as such. The information is general in nature and may omit detail that could be significant to your particular circumstances. The information is provided in good faith and derived from sources believed to be accurate and current at the date of publication. While all care has been taken to ensure the information is correct at the time of publishing, superannuation and tax legislation can change from time to time and Accurium is not liable for any loss arising from reliance on this information, including reliance on information that is no longer current. We recommend that you seek appropriate professional advice before making any financial decisions.