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When the mind’s no longer willing

Mental incapacity is a situation advisers need to be able to recognise with their SMSF clients. Following some premeditated steps can help safeguard against this issue, writes Caroline Harley.

Australians are an optimistic bunch; it’s fair to say we are all going to die, but only 50 per cent of us plan for it by having a will. If only 50 per cent of us are planning for a certain event, how many of us have a plan for something that is less certain but far more catastrophic, such as loss of mental capacity?

Members of an SMSF need to plan for this Armageddon-like situation, otherwise their super is at risk of losing its complying status and could be taxed at almost 50 per cent. In the event this does happen, it’s likely the surviving trustee or legal representative of the person who has lost capacity will want to blame someone. This is where you come into the picture. Did you see signs of loss of capacity that later escalated and remained unaddressed? Did you fail to advise your client about this as a risk or have an appropriate plan in place to deal with such an event?

Loss of mental capacity can result from a simple accident, which might occur while driving your usual route or even crossing the road. It can also occur due to mental illness or other conditions, such as dementia. According to Alzheimer’s Australia, every week there are more than 1800 new cases of dementia in Australia. This is around 370 cases for the average business day. If you think this won’t come across your desk as a problem, think again.

Loss of mental capacity in relation to an SMSF means a person can no longer make decisions in their position as trustee or director of a trustee. They no longer understand the facts and choices involved in the decisions they are being asked to make, nor do they have the ability to weigh up the consequences or communicate a decision.

When this occurs a substituted decision-maker needs to be appointed; someone who is empowered to step into the person’s shoes and make decisions on their behalf, provided the SMSF deed allows this. This can be done in one of two ways – either via a valid enduring power of attorney (EPOA) document signed by the member of the SMSF before they lose capacity (if you plan in advance), or appointment by the relevant tribunal or court in relation to their SMSF decision-making (where no advance planning has occurred).

Obviously having a plan in place that includes an EPOA document is the easiest, cheapest and best approach. Without planning, there is the issue of time, cost and the risk of someone else being appointed by the tribunal or court.

An EPOA document is a formal document where the member (principal) can appoint another person (attorney) to make decisions for them regarding their SMSF when they can’t do so anymore (that is, when they lose capacity).

There is different terminology in different states, such as donor and donee, but similar requirements and duties exist.

Our top 10 list will help you to consider the issues and steps to safeguard an SMSF from mental incapacity issues.

1. Every member needs a valid EPOA

Ensure every SMSF member has a valid EPOA (or advance person plan for the Northern Territory) in relation to their SMSF. This document should be drafted by a legal professional who also has access to the SMSF trust deed, will, binding death benefit nomination, living will, enduring guardian documentation (or equivalent in your state or territory). If you do not properly prepare the EPOA document using a professional who is aware of legislation and current cases, you might end up with a document that will not give the powers that are needed.

2. Careful with the EPOA wording

Each EPOA document should carefully consider what the member wants their attorney to be able to do and what they are not allowed to do. For instance, a member may not wish for their attorney to be able to make a new binding death benefit nomination or change a reversionary pensioner nomination. What other functions must the attorney be able to perform? Consider whether the action is permitted under the EPOA document and the SMSF trust deed. Merely because it is permitted by one, does not ultimately empower the attorney to perform that action. Essentially, the attorney needs to be empowered to do anything a member is able to, with any limitations agreed with the member.

3. Considerations where there’s a limited recourse borrowing arrangement

If the SMSF owns property interstate and has individual trustees/holding trustees, you need to ask why. It’s silly not to convert to a corporate structure for reasons including separation of assets, safeguarding against potential multiple penalties from the ATO and planning for loss of capacity. It is much easier to change the details of directors than to change the names on the title for assets. You will need to also include provision in the EPOA document and SMSF trust deed that allows for an attorney to perform the functions of a holding trustee and not just a fund trustee.

4. Interstate considerations with EPOAs

If a member relocates interstate, you need to be aware the law that governs EPOAs will change. The best course of action is to review the EPOA document before the move (if capacity has been lost) or prepare a new EPOA following the relocation (if capacity remains).

Rules vary among the states, for example, in Tasmania an EPOA document has no legal effect unless it has been registered.

Further, if the SMSF holds real property interstate, it may be a requirement that the EPOA document has been registered with the titles office or relevant registry. When that registry has other requirements, such as the EPOA document being printed double-sided or only accepted when lodged by the principal (SMSF member) before they lose capacity, this can create problems if the document was not prepared with these considerations in mind or lodged in time.

5. Don’t forget the details

Just because you were clever and have a valid EPOA document, don’t forget the attorney must still be appointed as a director of the SMSF trustee or as an individual trustee. Being recognised as an attorney under the EPOA document is not enough; it’s just the start. The attorney becomes eligible under the Superannuation Industry (Supervision) (SIS) Act as a ‘legal personal representative’ who is then allowed to apply to act as a trustee of an SMSF. If you are simply signing SMSF documents for a member as their attorney, this won’t cut it. You must be appointed in your own right to the position of trustee (or director) and sign as that office holder.

6. Corporate trustees

It’s important to remember that a company that acts as an SMSF trustee or even SMSF holding trustee is governed by its own set of rules. Just as the SMSF is governed by the trust deed and the SIS Act, a company is governed by its constitution and the Corporations Act. So if you are appointing an attorney as a director of a corporate trustee – as well as reviewing the rules for appointing the attorney under the SMSF trust deed – you need to make sure you follow the rules in the constitution and the Corporations Act. Specialist lawyers can take the headache out of this for you. You need to make sure you have a clear idea of what you need the ‘Armageddon plan’ to achieve before you ask the lawyers to help.

7. Have an ejector button option

Every ‘Armageddon plan’ needs an ejector button option. This is where things don’t go to plan and the SMSF can’t continue. It may be the attorney appointed by the EPOA refuses to act or has died since the document was originally prepared. Perhaps the attorney has become a bankrupt or now has a conviction that prevents them from being allowed to act as a trustee. Things happen that sometimes undo the best-laid plans.

As a result, your ejector button option may need to outline under what circumstances the SMSF is:

  • wound up and rolled over to an Australian Prudential Regulation Authority (APRA)-regulated fund, or
  • transferred to a small APRA fund.

8. Follow your instincts

Do you suspect a member of an SMSF has some capacity problems or has a co-trustee brought this up as an issue? Now is not the time to get a medical degree, but in order to cover your responsibilities it would be wise for you to conduct an informal capacity assessment. If you are an adviser or accountant, your professional indemnity insurer will thank you. It will also be a good indicator of where you are in your ‘Armageddon plan’, that is, should the attorney take over now.

9. Informal capacity assessments

You can conduct a brief chat with the member if you have suspicions or someone has raised this issue. The starting point is always that a person has capacity until you prove otherwise. So rather than proving the allegation, your purpose is to compile facts and reasoning that would indicate why capacity has been lost. If there is uncertainty, the next step may be to move to a formal assessment by a general practitioner or geriatrician (depending on the type of practitioner recognised by a tribunal or court in your state).

For guidance on how to conduct an informal capacity assessment take a look at the New South Wales government’s capacity toolkit. This is freely available online. It is specifically prepared for government and community workers, professionals, families and carers. While the document is produced in NSW, most of the information provided is general and not restricted to NSW.

10. Plan for Armageddon today

There are no guarantees in life, so the time to address this issue is now. Formulate the worst-case scenario’s for the SMSF and have alternative modelling, such as:

• if member A loses capacity and leaves member B,
• if member B loses capacity and leaves member A,
• if both members lose capacity,
• if one member loses capacity and the other member dies or vice versa, and
• if first nominated attorneys cannot act.

Planning for loss of capacity is often sidelined when everything is going well, however, it is critical to plan now. Unfortunately accidents happen and as a result SMSFs may not be able to function; often when a member is no longer able to sign documentation. The SMSF then becomes ‘locked’. Failing to function can result in loss of compliance and this can dramatically impact on the fund through loss of tax concessions. You simply cannot afford not to have these discussions and planning in place for an SMSF.

Monty Python famously said “always look on the bright side of life”, however, you would be better served remembering their other catchphrase, “nobody expects the Spanish inquisition”.

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