The last thing you want to happen is for your self-managed super fund to bump heads with the law. To avoid that, here are some key rules you need to check off:
- Your SMSF fits the definition of an SMSF
- You hold the appropriate trust deed
- You meet the ‘sole purpose test’
- Your SMSF is an ‘Australian Superannuation Fund’
- Your SMSF complies with the super laws
- There is no more than 5% in ‘in-house assets’
- You abide by investment restrictions
An SMSF that does not comply with these rules will be deemed ‘non- complying’ by the Australian Tax Office and face taxation consequences. In the year a fund is deemed non-complying, its income, including contributions, will be taxed at 45%. Further, the market value of the fund’s assets will be included in the fund’s taxable income and taxed. So, as a trustee, it’s very important that you understand and comply with all the rules.
The definition of an SMSF
Let’s start with the definition of an SMSF because that highlights a number of rules. An SMSF is defined as a fund that has all the following:
- Four members or less
- For individual trustees, each individual must be a member (except in single member funds)
- For a corporate trustee, each director of the corporate trustee must be a member (except in single member funds)
- Each member of the fund is a trustee, or is a director of the corporate trustee
- No member of the fund is an employee of another member of the fund, unless the members are relatives
- Trustees or directors of the corporate trustee can’t receive any remuneration from the fund
Under trust law, it’s not possible for an individual to be both the sole trustee and the sole beneficiary of the trust. So, as an exception to the above, SMSFs with only one member must have one of the following trustee structures:
- A corporate trustee where the member is the sole director of the company;
- A corporate trustee where the member is one of only two directors and the member is not an employee of the other director (unless related);
- Two individual trustees, provided the member is one of the trustees and is not an employee of the other trustee, unless they are relatives.
There are also some circumstances where an individual who is not a member of the fund can act as a trustee. This applies where:
- The member has died – in which case, the member’s legal personal representative can usually act as a trustee;
- The member is under a legal disability – the member’s legal personal representative or person holding enduring power of attorney can act as a trustee;
- The member has granted another person an enduring power of attorney; or
- The member is a minor – the minor’s parent can act as a trustee.
A member is:
- A person who receives a pension from the fund.
- A person who is eligible to make contributions to the fund (in the accumulation phase).
A relative is:
- A spouse, parent, child, grandparent, sibling, aunt, uncle, niece, nephew, first or second cousin as well as a spouse or former spouse of any of these people. It includes a person with such a relationship because of adoption or remarriage.
- A spouse includes another person who, although not legally married to the member, lives with the person on a genuine domestic basis as the de facto husband or wife of that person. This includes same-sex couples.
What is a trust deed?
An SMSF is governed by its trust deed, which sets out the rules of the fund. The Superannuation Industry (Supervision) Act (SIS Act) sets out some minimum covenants that all super funds needs to comply with. While a trust deed can stipulate more onerous regulations for the trustees to follow, it is not allowed to contain clauses which permit trustees to breach the act.
Some rules you must comply with are:
- To act honestly in all matters affecting the entity
- To exercise a degree of care, skill and diligence as an ordinary prudent person
- To act in the best interests of the beneficiaries
- To keep fund assets separate
- To formulate and give effect to an investment strategy
- To not do anything that would impede the proper performance and function of powers
- To manage reserves responsibly
- To allow beneficiaries access to certain information; and
- To do other acts as prescribed in the SIS Act.
Trust deeds can be amended by the trustees provided the amendment doesn’t clash with the act. For example, you can’t amend a trust deed to reduce a member’s entitlement. Trust deeds need to be reviewed regularly to make sure they remain consistent with the law.
What’s the sole purpose test?
The ‘sole purpose test’ requires super funds to be maintained for the single purpose of providing its members with retirement benefits. The test also allows the fund to be maintained for other ‘ancillary purposes’. To satisfy the sole purpose test, the fund must be maintained for one or more ‘core purposes’, and may also be maintained for one or more ‘ancillary purposes’. The ancillary purposes are optional and are not sufficient to pass the test without a core purpose.
The core purposes are:
- To provide benefits for each member after their retirement
- To provide benefits for each member after reaching the prescribed age (currently 65)
- To provide benefits to the legal personal representative and/or dependants of a member following their death, provided the death occurred before the member retired or reached 65 years old
The ancillary purposes include:
- To provide benefits for each member on or after termination of employment
- To provide benefits for each member on or after they temporarily or permanently cease work due to ill-health
- To provide benefits to the legal person representative and/or dependants of a member following the member’s death, where the death occurs after retirement or after reaching 65 years old
There is a strong interaction between the ‘sole purpose test’ and the leasing of assets to related parties under the in-house assets test. For example, personal use of a super fund asset by a related party without adequate compensation would be a breach of the ‘sole purpose’ test. Investments such as holiday houses, golf memberships and artwork can cause problems in this area.
Is your SMSF an Australian super fund?
An SMSF must be an Australian super fund to comply with regulations and access concessional tax treatments. The fund must be established in Australia, own an Australian asset, and the members must be residents of Australia. There are two parts to the test:
- The central management and control of the fund is ordinarily in Australia; and
- At least 50% of the assets of the fund relate to active members who are Australian residents.
These tests obviously impact members who temporarily or permanently leave Australia and cease to be Australian residents. It’s possible for a member who plans to live overseas for a period of time to pass the ‘central management and control’ test, provided they leave Australia with the intent to return.
However, while a member may temporarily reside overseas, they could cause the fund to fail the second test – that of at least 50% of the assets of the fund relating to ‘active’ members who are Australian residents – if they choose to make a contribution to the fund while living outside of Australia. An active member is someone who has contributed to the fund or on whose behalf contributions have been made. This is quite a complex area of taxation law and further guidance can be obtained from ATO Taxation Ruling TR 2008/9, or your accountant.
Meeting the compliance test
An SMSF can lose its complying fund status when it ceases to be an Australian super fund or fails the compliance test. Essentially, an SMSF will fail the compliance test when it has breached one or more of the provisions of the SIS Act. The seriousness of the breach will determine whether the ATO decides to issue a notice of non-compliance to the fund.
The 5% in-house assets rule
In-house assets are generally investments in, or loans or leases to, a party related to the fund. For more information on this rule, please read In-house assets.