Super funds face severe tax penalties if they lose their residency status.
The residency of your self managed superannuation fund (SMSF) is very important. If for some reason your fund loses its residency status at any stage during a financial year, it will face very severe tax penalties.
In the first full financial year that your fund loses its residency status, it will be taxed at 46.5 per cent. This tax rate will apply to the market value of the fund’s assets, less contributions not claimed as a tax deduction since June 1983.
The 46.5 per cent tax rate will then be applied to the assessable income of the fund for each full year that it continues to be a non-resident superannuation fund.
If a fund returns to being a resident superannuation fund, then it will again face 46.5 per cent tax on the fund’s assets. There is a potential total tax bill of at least 71 per cent on the assets of the fund if your fund moves from residency to non-residency and back again in two financial years.
Rules for residency
In the main, your fund will be a resident super fund if it satisfies the following three rules:
• The fund was established in Australia or any fund asset is situated in this country
• The central management and control of the fund is in Australia
• The fund has no active member, or if it has active members, then the assets of resident active members are more than 50 per cent of all assets of active members (active members are, in general, those members who receive or make super contributions during a financial year)
In many cases, Australians spending extensive time overseas struggle to satisfy the central management and control issue. That is, because they’re out of Australia for extended periods, often with uncertain return dates, their super fund is not being run within Australia.
Once a fund ceases to be a resident super fund, it can’t accept Super Guarantee contributions and, in most cases, employers will not get a tax deduction for any contributions they make to the fund.
How does the Australian Taxation Office (ATO) deal with these issues at a practical level? Many people ask the ATO for a Private Binding Ruling about their particular circumstances.
‘Central management and control’
In one particular case, a couple born overseas emigrated to Australia more than 10 years ago. One had become an Australian citizen, the other hadn’t. They operate a business through a company that makes employer contributions to their SMSF.
The couple intend to travel overseas during three financial years and will return to Australia permanently. During their holiday, they’ll travel on tourist visas and have no intention of working overseas. While out of the country they will live off their accumulated savings. They will manage their business via the internet and have organised to have business-related postage scanned into an electronic format and made securely available to them. They will appoint a person to provide administrative services to carry out these duties.
The couple initially told the ATO that they were unsure when they would return to Australia.
Of less importance to us, the couple asked the ATO if they would personally remain residents for income tax purposes. The ATO concluded they would be.
The couple also wanted to know if their super fund would remain a resident super fund.
The ATO said no for the following reasons:
- Their fund was established in Australia and an asset of the fund was held here in Australia. This rule was satisfied without any problem.
- What about central management and control (CM&C)? The Taxation Office noted that CM&C will be deemed to be in Australia if most of a fund’s trustees are overseas for less than two years.
The questions we ask the ATO are just as important as the answers.
If you’re going to be away from Australia for more than two years, then CM&C won’t be deemed an issue if you’ll be away temporarily. In this particular case the ATO decided the fund trustees manage and control their fund – which of course they’re meant to do.
Importantly they intend to continue performing this role whilst overseas on holiday. (They will do this in the same way they plan to run their business.)
The couple had no intention of appointing anyone to help them perform these functions such as a person holding an enduring power of attorney.
The ATO initially concluded that they wouldn’t be away for a short period of time and had no definite date of return to Australia and as a result the CM&C of the fund would be overseas.
Therefore, the fund didn’t satisfy the CM&C requirement whilst the members were going to be away from Australia.
The couple then went back to the Taxation Office and said they would return to Australia no later than a particular date. The ATO said their absence from Australia was now a defined period and as a result the fund’s central management and control would remain in Australia.
As noted, the ATO had said that the couple would remain residents for their personal income tax affairs. As they are the only members of their fund, it only has resident active members and so the third and final test is satisfied fully.
As all three resident super fund tests were satisfied, the fund would remain a resident super fund during the couple’s holiday. Assuming there were no significant regulatory breaches, the fund would remain a complying super fund which means that their employer could continue to make Super Guarantee contributions to the fund during their overseas holiday.
Asking the right questions can be as important as the answers
The primary lesson from this case is that the questions we ask the ATO are just as important as the answers. But this also shows that when asking the ATO for an opinion, we need to ensure we understand all the nuances of the law for the area we need advice on, so that we know how to provide the relevant information.
Before the ATO adjusted its view, the SMSF trustees were confronting not only a non-resident super fund but also their related employer wouldn’t be allowed to make Super Guarantee contributions to their fund. Thankfully for the couple, both these issues are now “off the table” because they were able to readjust the information they provided to the ATO.