Are you an SMSF member and planning to travel abroad for leisure, study, or work? If that’s you, you must be aware of SMSF residency rules.
SMSF residency rules are designed to ensure that superannuation funds operate inside Australia, safeguard the fund’s compliance status, and continue enjoying concessional tax status.
Breaching the residency rules could lead to loss of tax concessions, civil or criminal penalties, or forced winding up of your fund.
This article aims to inform you about SMSF residency rules, the consequences of breaching them, and how to stay compliant, ensuring your fund remains robust and secure.
SMSF Residency Rules Property Investors should be aware of
Establishing the Fund in Australia
This test is met if the fund was established and the initial contribution to start the SMSF was paid and accepted by the trustees in Australia. For funds outside Australia, you can still meet this test if at least one of the fund’s assets is located in Australia.
This is the easiest test to satisfy and is often not an issue for many funds.
Central Management and Control Test
The SMSF’s central management, administration, and decision-making must be based in Australia. This is not a straightforward test. It’s highly subjective based on where the strategic, investment-based, and other decisions concerning the SMSF are made.
The day-to-day running and administrative activities of the SMSF aren’t part of its central management and control. Central management and control are the high-level and strategic decisions made concerning the SMSF. They include:
- Formulating the fund’s investment strategy
- Reviewing and updating the fun’s investment strategy and monitoring the performance of the fund’s investments
- Formulating a strategy for the prudential management of the fund’s reserves and determining how the fund’s assets will be used for the members’ benefits
SMSF trustees can seek professional advice but can’t delegate the responsibility of making strategic and high-level decisions to a third party. An SMSF trustee acting on the advice of a third party is still considered central management and control.
To meet this test, you must take note of the term ‘ordinarily in Australia’. Typically, the physical location at the time of making decisions determines where the central management and control are located.
However, the concept of ‘ordinarily in Australia’ allows for central management and control decisions to be made by someone temporarily outside Australia.
Active Member Test
SMSF active members are members making contributions to the fund or having contributions made on their behalf by their employers. These active members must be Australian residents and must hold at least 50% of the SMSF’s assets or at least 50% of the members’ payable contributions.
For example, let’s say your SMSF has five members. If only three members make contributions or have contributions made on their behalf, then your SMSF has three active members. To meet the active member test, the balances of these three members must be at least 50% of the total fund balance.
A fund without active members that meet rules 1 and 2 can still be considered an Australian super fund.
An SMSF should be cautious when accepting contributions from members who are abroad and aren’t considered tax residents unless there are tax-resident active members who meet the 50% rule.
Some fund members may choose to make contributions to a larger available fund when overseas and don’t qualify as Australian tax residents. Once they come back to Australia and regain their tax-residence status, they can roll over the benefit to their SMSF.
Temporary Absences Rule
Trustee functions can be conducted outside Australia temporarily for up to two years. This enables trustees to relocate for a short period. The central management and control can be considered ‘in Australia’ even when the trustees are outside the country for a relatively short period.
However, this rule doesn’t apply if central control and management permanently relocate from Australia, even if you move for less than two years.
If you move outside Australia temporarily for a period shorter than two years but end up staying longer than two years due to unforeseen circumstances, any mitigation measures may have to apply.
Here are some factors that would make your absence not appear temporary:
- Leaving Australia for an undetermined time
- Selling the family home in Australia
- Not booking a return flight
- Purchasing an overseas home as your new residence
- Entering into a long-term lease on an overseas property
- Contract of employment in a foreign country is longer than two years or for no predetermined period
- The contract of employment has renewal clauses
- Relinquishing all connections with Australia or denouncing Australian citizenship
- Acquiring citizenship in a foreign country
Where a trustee was unable to return to Australia due to travel restrictions, such as pandemic lockdowns, the SMSF may still be considered a temporary absence even though the trustee has been overseas for over two years.
If all trustees move to different countries, the SMSF will likely not meet the superannuation fund test from the date of departure. In this case, the trustees will have to resign and appoint new trustees, who are granted enduring powers of attorney.
Implications of Non-Compliance with SMSF Residency Rules
SMSFs that fail to comply with the superannuation fund residency rules are likely to suffer the following consequences:
Tax Consequences
A non-compliant superannuation fund loses its entitlement to SMSF tax benefits. You will no longer be taxed at the concessional rate of 15%, which applies to the income of a compliant SMSF.
As a result, the fund will be taxed at a higher marginal rate of 45% charged to the entire value of the fund’s assets minus any non-deductible contributions.
The higher marginal tax rate is also applied to any income earned and capital gains, which significantly affects the fund’s overall value and retirement benefits.
Also, non-complying SMSFs are considered to have disposed of their assets at market value. This may trigger a CGT event and lead to a substantial tax liability.
Legal Consequences
Breaching the SMSF residency rules could lead to legal action from the Australian Tax Office (ATO), including penalties and enforcement actions. This could attract further scrutiny from the ATO, leading to more penalties if other issues are found.
As for the trustees of the fund, they may be held liable for breaching the Superannuation Industry (Supervision) Act 1993 (SISA). The non-complying status can also impact the benefits the members are entitled to, affecting their retirement benefits and financial stability.
Practical Considerations for SMSF Property Investors
Managing Central Management and Control
Ensure that the fund’s central management and control is ordinarily in Australia. This means that the strategic and high-level decisions concerning the SMSF are made in Australia, even if the trustees are temporarily overseas.
If the trustees plan to be overseas for an extended period, consider appointing a representative residing in Australia through an enduring power of attorney to make decisions on behalf of the SMSF.
Active Member Strategies
Consider the residency status of the active members and ensure that no non-resident active members are contributing to the fund. If any of the members are considering leaving Australia for a certain period, make arrangements for them to pause their contributions, to avoid breaching the active member test.
Regular Reviews and Audits
SMSFs are required by law to conduct regular reviews and audits. It’s especially important to regularly review the fund’s residency status when some of the fund’s members temporarily move overseas.
This involves reviewing where the central management and control decisions are made and ensuring they align with the residency rules.
Also, consider engaging an independent auditor to regularly assess your fund’s alignment with the residency rules. An external auditor can also help you spot potential breaches before leading to issues with the ATO.
Professional Advice and Support
In the same breath, consider working with experienced financial advisors, tax consultants, accountants, and legal experts who are well-versed in SMSF residency rules.
These professionals can provide customized advice to help you with compliance based on your situation, such as when you have SMSF members living abroad or when your fund is considering international investments.
Travelling overseas for a long period or living overseas
If you have any trustees travelling abroad, they should ensure that their stay won’t exceed two years. Staying beyond two years makes it difficult for your SMSF to prove that central management and control remain in Australia.
Be sure to plan ahead if travelling. Consider the implications of your absence on the fund’s residency status and precautionary measures to mitigate risks, such as appointing a local attorney or installing a management plan to ensure the central management and control remains in Australia.
If staying overseas for an extended period and maintaining the fund’s residency compliance is impractical, consider rolling over the SMSF to a public super fund.
Do residency rules still apply if I’ve reached retirement age?
Yes. Income from the SMSF assets is tax-free once you’ve entered retirement and hit preservation age. If the fund breaches any of the residency rules, the ATO may remove the tax-free benefits.
In other words, you must meet the residency rules even in retirement to be considered an active member of the SMSF.
Even if you’re no longer making contributions or having contributions made on your behalf into the SMSF and you want to spend your retirement years seeing the world, it’s important that you don’t stay away from Australia for more than two years.
If you exceed two years outside Australia, you’ll be in breach of the second residency rule (central management and control test).
And you can’t skip this issue by not receiving pension payments when you’re overseas for more than two years. This is because superannuation guidelines have a minimum annual pension payment rule that you must receive to be compliant.
Key takeaways for SMSF property investors
For those SMSF members who have already invested in property, please be aware of the residency rules that your SMSF must comply with. Noncompliance can result in very serious consequences and can affect your retirement goals.
We advise our clients to seek professional advice from a trusted SMSF buyer’s agent to ensure they remain compliant.
