Divorce gives rise to a number of issues for SMSFs to deal with, making specialist advice a must when faced with the unpleasant predicament, writes Peter Burgess.
Here are two figures to ponder. According to the Australian Bureau of Statistics, about one in three marriages end in divorce. At the same time, the Australian Taxation Office (ATO) informs us there about 478,000 SMSFs, of which many have husbands and wives as joint trustees. So the sad reality is many of these funds will become a battleground as former couples fight for what they perceive to be their fair share of the spoils.
It’s not hard to see how this can quickly become a problem. Take, for example, an SMSF whose primary asset is a business premises being leased to a family business, a common enough occurrence. Valuation puts a figure of $2 million on it and, for argument’s sake, let’s say the wife’s share of the fund balance is $1 million. How can the fund pay out the wife’s share without having to sell the business premises? The family business may not be able to afford to purchase the premises from the fund and the wife may no longer want to be involved in the business.
It’s not just business assets. Other assets that sit in SMSFs cannot easily be ascribed a dollar value, such as property or collectables, often leading to lengthy, bitter disputes.
Such issues can be resolved, especially if goodwill remains on both sides. But goodwill is often hard to find when couples split – that’s why they are getting divorced. It often means disputes end up in the courts, where settlements can be lengthy – years, not months. There are even examples of where one of the spouses flees the country, with the verdict in one recent court case finding the former wife, in her role as a trustee of the fund, was personally liable when it became non-complying after her former husband stripped out most of the assets and headed overseas.
The court’s judgment might seem unduly harsh. But it was simply applying the letter of the law, as the ATO clearly states: “If you are a SMSF trustee or member and your relationship breaks down, you must continue to act in accordance with the super laws and the trust deed of your fund.”
In other words, just because your marriage is on the rocks, it does not absolve you from your responsibilities as a trustee.
When couples set up an SMSF, they do so in the knowledge that the responsibility of managing it rests solely with them. They have to make the decisions, with specialist advice, about issues such as meeting their legal responsibilities and having their fund audited. So despite any difficulties people have at an individual or personal level, the ATO says, quite categorically: “A trustee must continue to act in the best interests of all members at all times.”
More specifically, trustees cannot:
- exclude another trustee from the decision-making process;
- ignore requests to redeem assets and roll money over to another regulated complying super fund;
- take any action that is not allowed by the Superannuation Industry Supervision (SIS) Act 1993 or the SMSF’s trust deed.
The problem can arise when one trustee has simply been ‘signing the papers’ over the years, so when the marriage dissolves they do not understand their legal responsibilities. The consequences can be dire, as the ATO takes a very dim view of trustees who fail to meet their fiduciary duties. An SMSF can be made non-complying and be hit with significant tax penalties. There’s also the possibility of being disqualified as a trustee. (As an aside, these legal obligations apply to all relationship breakdowns, whether it is between father and son, brother and sister, or uncle and niece, or even friends. Legal proceedings between trustees or members of your SMSF do not suspend your trustee obligations.)
To help couples through this difficult time, the legislation makes some important concessions that allow a trustee to acquire assets from a related party of the fund as a result of marriage breakdown without breaching the rules, which would normally prevent such a transaction.
So what are some of the specific issues that can arise in relation to an SMSF when a marriage breaks down?
Asset valuations
Before any settlement can be agreed on or ordered by the court, the assets of the fund need to be valued. This can be a difficult task if the SMSF holds property and others forms of unlisted investments, such as units in trusts and shares in a private company. It may be necessary for a ‘payment flag’ to be placed on the member’s interest in the fund until such time that an appropriate valuation can be conducted. A payment flag has the effect of preventing the trustees from paying out that interest until such time that the value of the superannuation is known and the flag has been lifted via a flag lifting agreement.
Business Assets
As mentioned, difficulties can arise if the SMSF owns a business premises that is being used by either the husband or wife to run their business. Unless there are sufficient liquid assets in the fund to allow the fund to pay an amount sufficient to cover the benefit payable to the divorcing spouse, the divorce may require the business premises to be sold. This could also affect other business partners. A possible solution to the situation is that if the business premises had been acquired under a unit trust structure, it may be possible for the fund to now transfer the business premises out of the unit trust and for the fund to redeem its units in the trust for cash. The SMSF trustees could then acquire a beneficial interest in the business premises by executing a limited recourse borrowing arrangement. The end result is the fund has sufficient liquidity to pay out the benefit to the divorcing spouse and the SMSF trustee still retains a beneficial interest in the business premises via a limited recourse borrowing arrangement.
Trustee restructure
If the husband and wife are the individual trustees of the SMSF, and either the
husband or the wife is now leaving the fund, the remaining trustee will need to find another individual to act as a co-trustee of the SMSF, and then all of the assets of the SMSF will need to be registered in the names of the new trustee. This issue doesn’t arise if the trustee of the SMSF is a corporate trustee (which is another reason to establish your fund with a corporate trustee in the first place).
Trust deed
In some rare situations, in the event of divorce, a non-member spouse may request that a separate interest be set up in the SMSF of their divorcing partner rather than requesting it to be rolled over to another fund. In these situations, unless there is a specific clause in the SMSF trust deed that prevents the separate interest being set up, the member must comply with the wishes of their ex-spouse. The ex-spouse would then need to be appointed as a trustee of the SMSF, allowing them to exercise some level of ongoing control over the fund. To prevent this, trust deeds should be set up with a clause that prevents an interest for a non-member spouse being established in the fund in the event of divorce.
Specialist advice
In a husband and wife SMSF, unless the divorce is dealt with quickly, there will be a period where both divorced members must make joint decisions as trustees of the fund. This can be difficult as many fund transactions and events, such as signing cheques, tax returns, financial statements and making investment decisions, usually require both trustees to sign. It is a good idea for both parties to have their own SMSF specialised adviser to assist both parties to properly fulfil their duties during this time. This also gives a certain amount of impartiality to the activities of the fund until the divorce procedures have been finalised.
CGT rollover advice
Assets transferred from the SMSF to another super fund as a consequence of divorce are entitled to certain capital gains tax (CGT) concessions. Basically, the transfer is not subject to CGT and the original cost base of the asset becomes the original cost base in the new fund. Care needs to be taken to ensure assets are transferred in specie to the new fund rather than the SMSF selling the asset first and then transferring the cash proceeds to the new fund. If the asset is sold first, the sale proceeds will not be eligible for the CGT concessions.
Divorce is often messy and having an SMSF often complicates matters further. An SMSF specialist can help to structure the fund and its investments, in a way that minimises the complexities and issues that often arise when SMSF members divorce.
