Changes to Residency – Technical SMSF Audit Considerations
In this blog series, CaseWare’s SMSF Audit expert and content provider Sharlene Anderson, outlines common technical SMSF issues, and what auditors need to consider for each.
An Australian Superannuation Fund is defined in s295-95 of ITAA 1997 at a point in time, and for the income year in which that time occurs, if:
a. the fund was established in Australia, or any asset of the fund is situated in Australia at that time; and
b. at that time, the central management and control of the fund is ordinarily in Australia; and
c. at that time either the fund had no member covered by subsection(3) (an active member) or at least 50% of:
i. the total * market value of the fund’s assets attributable to * superannuation interests held by active members; or
ii. the sum of the amounts that would be payable to or in respect of active members if they voluntarily ceased to be members; is attributable to superannuation interests held by active members who are Australian residents.
3. A member is covered by this subsection at a time if the member is:
a. a contributor to the fund at that time; or
b. an individual on whose behalf contributions have been made, other than an individual:
i. who is a foreign resident; and
ii. who is not a contributor at that time; and
iii. for whom contributions made to the fund on the individual’s behalf after the individual became a foreign resident are only payments in respect of a time when the individual was an Australian resident.
4. To avoid doubt, the central management and control of a * superannuation fund is ordinarily in Australia at a time even if that central management and control is temporarily outside Australia for a period of not more than 2 years.
ATO Taxation Ruling TR 2008/9[1] provides detailed guidance on this definition. See also ATO publication Residency of self-managed super funds[2].
For a superannuation fund to receive the concessional tax rate of 15% it must be a complying superannuation fund (s26 Income Tax Rates Act 1986). Via s995.1 of ITAA1997 Complying Superannuation Fund is defined in s45 of SISA. S42 of SISA prescribes that to be a Complying Superannuation Fund in relation to a year of income, along with the criteria of section 45, the fund must be a resident regulated superannuation fund.
In an income year when a fund was previously a complying superannuation fund becomes non complying, in the context of this discussion due to failing to meet the residency requirements, s295.320 ITAA 1997 causes ordinary income and statutory income from previous years to be included in assessable income for that year at normal marginal tax rates as well as the income for the current year. The formula for working out the amount is in s295.325 ITAA 1997.
The consequences for the fund of becoming a non-complying fund by failing to meet the residency test will be expensive. For other breaches of SISA the commissioner has discretion whether or not to make the fund non-complying. It appears that no such discretion exists when the fund fails the residency test.
For the auditor, if a fund fails to meet the residency test and the tax expense of the fund has been based only at 15% of the current year income, the audit risk will be that an unmodified opinion is given at Part A of the audit report in relation to the financial audit of the fund whereas the audit report should be modified as a result of the understatement of tax expense and income tax payable which will be materially understated given that the market value of all fund assets, less undeducted contributions since 1983, should have been reported as taxable income at the marginal tax rate.
Auditors should therefore be alert during the audit to addresses for correspondence for trustees on bank statements for example and locations of meetings held rather than simply relying on a trustee representation letter confirming residency status of the fund.
The most common issue with fund residency is the second limb of the residency test where central management and control of the fund becomes ordinarily outside of Australia for a period of more than two years.
Taxation Ruling TR 2008/09 describes the nature of central management and control at paragraph 20 as:
20. The CM&C of a superannuation fund involves a focus on the who, when and where of the strategic and high level decision making processes and activities of the fund. In the context of the operations of a superannuation fund, the strategic and high level decision making processes includes:
● formulating the investment strategy for the fund;
● reviewing and updating or varying the fund’s investment strategy as well as monitoring and reviewing the performance of the fund’s investments;
● if the fund has reserves – the formulation of a strategy for their prudential management; and
● determining how the assets of the fund are to be used to fund member benefits.
21. The other principal areas of operation of a superannuation fund that form part of the day-to-day or operational side of the fund’s activities will not constitute CM&C. These activities do not form part of the CM&C of the fund because they are not of a strategic or high level nature. Rather, these activities are of a more formalistic or administrative nature. Examples of such activities include the acceptance of contributions that are made on a regular basis, the actual investment of the fund’s assets, the fulfilment of administrative duties and the preservation, payment and portability of benefits.
It is therefore the higher level management considerations of the fund that form the central management and control. The ruling goes on to explain that who is exercising central management and control is a question of fact for each case. The ruling notes that a person other than a trustee can exercise the central management and control, if they perform the duties independently and without any influence from the trustees.
It is not unusual for members of a SMSF who are going overseas for a period of more than two years to attempt to ensure that central management and control remains in Australia by donating their enduring power of attorney to persons who reside in Australia.
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[1]http://law.ato.gov.au/atolaw/view.htm?DocID=TXR/TR20089/NAT/ATO/00001&PiT=99991231235958
[2]http://www.ato.gov.au/Super/Self-managed-super-funds/In-detail/Establishing-and-maintaining/Residency-of-self-managed-super-funds/