SMSFs must pass residency requirements at all time to be eligible for the tax concessions that are available under Australian superannuation legislation. Member contributions and fund earnings in compliant Australian SMSFs are taxed at the concessional super rate of 15%, up to certain contributions limits.
What is the SMSF residency test?
The three residency rules or conditions that an SMSF must meet to be classified as an Australian super fund are listed below.
The initial contribution to set up the SMSF must have been paid and accepted in Australia (or the fund must have at least one Australian-based asset).
The SMSF’s ongoing management, administration and decision-making must usually be conducted in Australia.
It’s important to remember that all members of an SMSF must also be trustees that are responsible for ensuring its legal compliance. While trustees can obtain professional advice to help them with SMSF management and compliance, the residency/rule condition cannot be outsourced to a third party.
However, it’s possible for trustee functions to be temporarily done outside Australia for up to two years, enabling fund members/trustees to temporarily relocate.
The fund’s active members (i.e. members making fund contributions or having contributions made on their behalf) must be Australian residents and they must hold at least 50% of its assets (or at least 50% of the amounts payable to members).
Alternatively, a fund with no active members that meets residency rules/conditions 1 and 2 can still be classified as an Australian super fund.
To avoid the risk of your SMSF becoming non-compliant due to member/trustee residency issues, any members who goes overseas for longer than two years should avoid making contributions to your fund (or having any contributions made on their behalf).
Instead, their contributions should be made to a retail or industry super fund. These retail/industry account balances would then be eligible to be rolled over into your SMSF if/when the member/trustee returns from overseas.
What happens if you breach the SMSF residency rules?
SMSFs that fail to satisfy all three residency rules/conditions at all times are likely to be classed as non-compliant by the ATO. This can result in the fund’s assets being frozen and its income (member contributions and investment earnings) being taxed at the highest marginal tax rate (45%).
The ATO also has the power to order a non-compliant SMSF to be wound up and transfer their member’s funds to a public super fund.
However, the ATO will take any mitigating circumstances into account before imposing a penalty on an SMSF that breaches any residency rules/conditions, as highlighted by one of their recent decisions below.
A husband and wife were trustees of their own SMSF. They divorced, and the husband subsequently relocated overseas for two years and eight months. This put their SMSF in breach of residency rule/condition 2.
The ATO could potentially have retrospectively taxed the fund’s income at the highest possible rate for each of the three financial years that the husband was away. This would have resulted in a one-off tax bill of more than 50% of the value of the assets in the SMSF.
However, the ATO took into account three mitigating facts in deciding not to impose a tax penalty:
- the husband and wife voluntarily disclosed the breach.
- the husband was terminally ill.
- the super benefits of the couple were subject to a Family Court order as part of their divorce settlement.
Can I return to Australia for a week each year to pass the test?
If you’re living overseas for an extended period (i.e. more than two years), returning to Australia for a week each year won’t satisfy residency rule 2 (i.e. that the ongoing management and decision-making of the fund occurs in Australia).
In addition, if you make contributions to your SMSF during this time, you’ll be in breach of residency rule/condition 3 (i.e. that an SMSF’s active members must be Australian residents). You wouldn’t be an Australian resident for tax purposes while you’re living permanently or for an extended period overseas, which means you wouldn’t be entitled to super tax concessions via your SMSF.
Do the residency rules differ for those in the retirement phase?
No. It’s important to understand that income from SMSF funds in the pension phase are tax-free, and a breach of any of the three residency rules can result in the ATO removing this tax-free status.
You can still be eligible to be an active member of an SMSF (i.e. make contributions) even when you’re in the retirement phase, but if you do, you still need to satisfy SMSF residency/condition rule 3 (i.e. be an Australian resident).
And even if you’re not making SMSF contributions and are spending your retirement years travelling, it’s important that you don’t stay away from Australia for longer than two years. Otherwise, you won’t comply with SMSF residency rule 2 and will risk the tax-free status of your pension.
Avoiding receiving pension payments while you’re living overseas for more than two years isn’t an option to avoid this issue. That’s because there are minimum annual pension payments that you must receive to comply with super legislation. This amount depends on your age, as indicated in the table below.
|Your age (as at 1 July of the financial year)||Minimum payment amount (expressed as a percentage of your SMSF pension account balance)|
|95 or more||14%|
Can I set up an SMSF while I’m living overseas?
Yes, provided that you’ll return to live in Australia within two years of setting your SMSF up.
Australian superannuation legislation provides tax concessions for compliant super funds. There are three residency rules that an SMSF and its members/trustees must satisfy at all times to be eligible for these tax concessions. Failure to satisfy any of these rules can result in your SMSF having its assets frozen or its income taxed at the highest marginal rate (45%).
The information contained in this article is general in nature. It’s best to seek independent professional advice to determine how the residency requirements apply to your specific SMSF circumstances.