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The residency test: Crucial for SMSFs and overseas travellers

Jun 16, 2023, 10:20 AM
Graeme Colley 800x800px

By Graeme Colley
Executive Manager, SMSF Technical & Private Wealth

Residency test

ATO Residency test for SMSFs

If you are a member of an SMSF and about to depart Australia for an extended period or permanently, you may be faced with your SMSF failing the residency test.  If your SMSF is to continue as a complying superannuation fund and enjoy concessional tax treatment, it must always satisfy the ‘residency test’ - no exceptions.

An SMSF that fails the residency test will lose concessional tax treatment and be taxed at 45%.  The higher tax rate will be payable on the fund’s investment income plus the market value of the assets, less the amount of non-concessional contributions made to the fund. Potentially up to 45% of the value of the SMSF could be lost in tax – something no one wants to face.

Demonstrating residency 

A resident SMSF must meet the definition of an “Australian Superannuation Fund” in the income tax legislation and always satisfy three very specific requirements at all times. These are an establishment test, a control test and an active member test.

Test 1 - The establishment test

The establishment test is met if the fund was established in Australia or an asset of the fund was situated in Australia.  Nearly all SMSFs have a trust deed that was executed in Australia and will meet this test.

Test 2 - The central management and control test

The central management and control test is about the strategic and high-level decision-making processes and activities that are undertaken by the fund’s trustee.  This includes formulating and reviewing the fund’s investment strategy and monitoring investments.

The day-to-day administrative activities of the fund are not part of the central management and control test.  Administrative activities include the actual investment of fund assets, acceptance of contributions and payment of benefits.
Meeting the central management and control test - Temporary absence from Australia
The central management and control of a fund can be regarded as being ‘in Australia’ even where the trustees may be overseas for a relatively short time. Temporary absence can be for no more than two years when the trustees may be on vacation or for employment, for example. During the COVID-19 pandemic, when a person was unable to return to Australia due to travel restrictions, the SMSF may still be considered as ‘temporary absence’ although the trustee may have been overseas for an extended period.
Where all trustees emigrate to another country, the fund will likely not meet the Australian superannuation fund test from the time of departure.  In this situation, the trustees may need to resign and have new trustees, who have been granted enduring powers of attorney, appointed in their place.

Test 3 - The active member test

The active member test is the ‘sting in the tail’ of the definition of an Australian superannuation fund.  It applies where a member who is a non-resident for tax purposes may contribute or roll over to the fund.  SMSFs are more likely to fall foul of this rule than larger super funds.

Where contributions or rollovers have been made in respect of a fund member in a financial year, they are treated as an ‘active member’.  To meet the active member test, at least 50% of the fund balances of active members must relate to Australian residents for income tax purposes.

It is prudent that an SMSF should exercise caution when accepting contributions from members who are overseas and are not considered tax residents unless the fund has tax-resident active members who meet the 50% rule.

Some fund members may choose to have contributions made to a larger publicly available fund when they are overseas and are unable to qualify as Australian tax residents. Once they return to Australia and regain their tax resident status, they may roll over the benefit to their SMSF.

Enduring powers of attorney (EPOA)

One possibility to retain the fund’s status as an Australian superannuation fund could be for the member to grant an Enduring Power of Attorney to someone they trust to make decisions about the SMSF.  Granting an EPOA to a person doesn’t give them the right to make decisions on behalf of the fund.  However, the superannuation legislation does permit them to be formally appointed and take the place of the trustee or director of the corporate trustee.

When the central management and control is delegated to another person, it is important they undertake those responsibilities in their own right rather than under the influence of the grantor of the EPOA. If the replacement trustee passively accepts instructions from the grantor, the ATO has indicated that the central management and control test would not be met.

Combination of EPOA and an equal number of trustees

A common option for a fund with two trustees both going overseas is for one of the existing trustees to grant an EPOA to a person who will remain in Australia.  The grantor would then resign as trustee of the fund and be replaced by the Australian resident.

If the SMSF has a corporate trustee, it is possible for the director to nominate an alternate trustee who is able to act as a director while the appointed director is overseas.  This can be a simpler option to the granting of an EPOA and another’s benefit of having a company as a trustee of the SMSF.

Small APRA Fund 

An alternative to retaining the SMSF could be to have an approved trustee take over the administration of the fund.  In this situation, the SMSF would convert to a ‘Small APRA Fund’ and be regulated by APRA. This would overcome the central management and control issue, as the approved trustee would be resident in Australia.

Dealing with residency before leaving Australia

It is important that residency issues are addressed well in advance of the trustees leaving Australia.  Making decisions about the trusteeship of the SMSF close to the time of departure or after may be too late as there are probably more important things that take priority.  Even worse, the issues may not be discovered until the trustees have returned to Australia.

The residency test is one that must be met “at all times” and, once failed, cannot be rectified retrospectively, which may result in significant adverse tax consequences. Anyone planning to travel overseas, when it is possible, will need to consider whether the SMSF will continue to meet the residency test. If in doubt, professional advice is worthwhile prior to departure or it may be too late.

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