Expert SMSF insights
Can we simplify the residency rules for SMSFs?
By Philip La Greca
- Meeting the definition of ‘Australian Superannuation Fund’
- The Board of Taxation proposed two-step determination for residency
- What this would mean for SMSFs
Since July 2007 we have worked with a new definition of what is an 'Australian Superannuation fund'.
Meeting this definition is critical as failure results in an SMSF being treated as a non-resident fund which means it is non-complying for tax purposes and its headline tax rate rises from 15% to 45%. This definition involves three tests which must be all met to ensure an SMSF is not treated as non-resident, namely;
- The Australian asset or establishment test,
- The active member test, and
- The central control & management (CM&C) test.
These tests are designed to ensure the tax concessions afforded to superannuation savings are only utilised by Australian residents. In practice, applying these tests can be difficult and over the years there have been many calls for a simpler, more practical approach to protecting the integrity of the super system.
So why are we discussing this?
The Board of Taxation recently reviewed the current approach used to determine a person’s residency status and has come out with a simpler model which if applied to SMSFs could be used to rid us of the active member test.
The Board of Taxation is proposing a two-step determination for residency - step one is at least 183-days present in Australia in a 12-month period and a second factor-based test that is applied if the days' test is not met. The second test will consider a range of factors that will determine residency namely, time spent in Australia, immigration status, location of family, Australian accommodation accessibility, and economic ties to Australia.
What this would mean for SMSFs
Using this proposed residency test for SMSFs could help eliminate one of these superannuation residency tests and thus simplify the steps involved for ensuring SMSFs maintain their complying status if a member goes overseas.
Satisfying the Australian asset or establishment test is a simple matter of fact, either the SMSF was established in Australia or it owns an Australian asset. The remaining two tests are more problematic as the active member test looks at the tax residency status of the member when they make contributions or rollovers and the CM&C test looks at where the trustees are located when decisions are made.
The prudent use of Enduring Power of Attorneys can solve most of the issues for the CM&C test. This is often done by replacing the offshore member with a resident trustee holding an Enduring Power of Attorney for the offshore member. The ATO ruling TR2008/9 even permits this such that not even all offshore members need to grant Power of Attorneys, only enough members such that half the trustees are residents.
Which leaves us with the active member test where the tax residency status of member is critical.
Now, this test is only is relevant for personal contributions and rollovers as there is recognition that employers make contributions in respect of employment periods and for employees who generally must be residents for tax purposes for an employer to be able to claim a tax deduction for the contribution.
In my view rollovers should be excluded from this test because if the other two residency tests are met (Asset or establishment test and CM&C test) we are not adding new money to the superannuation system only moving existing money between different complying superannuation funds. This would eliminate the current discrimination which would exist where a person who is overseas can move their benefits between APRA regulated funds with no consequence and even from an SMSF to an APRA regulated fund but would be prevented from rolling from an APRA regulated fund to an SMSF.
This then leaves the requirement for personal contributions.
A simpler approach would be to only permit these contributions if the member was a resident for tax purposes in the financial year the contribution is made. Doing this would mean we could remove the active member test entirely.
Now, what would happen if a contribution was made and the member wasn’t a tax resident?
In my view, there is an alternative to making the SMSF non-complying. What if instead, we use the existing mechanism in place to refund excess non-concessional contributions to refund the contribution made by a non-resident SMSF member?
All contributions are already reported to the ATO and the information includes the member’s name, Date of Birth and Tax File Number. It would thus be possible for the ATO to determine if the member was a resident for tax purposes and if the person was not a resident, issue the equivalent of an excess contribution release authority to the SMSF.
All this would streamline the issues that need to be addressed for SMSF members moving overseas and still maintain the integrity of the superannuation system.
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