Documentation, Superannuation

Inflexible residency test should be dumped

SMSFs residency test

The residency test for SMSFs is easy to fail and offers no incentives for trustees to re-comply when they don’t pass it, the Tax Institute has claimed.

The residency test for SMSFs should be dropped as it does not prevent non-residents from contributing to an Australian superannuation fund, according to the Tax Institute.

The test also has no flexibility and there is no incentive for a fund to regain its status as an Australian superannuation fund if that status is lost, the institute claimed in a letter to Treasury.

The letter, signed by Tax Institute president Tim Neilson, stated its purpose was to “outline our suggested solution in relation to the ‘residency status for self-managed superannuation funds’ issue”, which was raised in meetings with Treasury and the ATO in mid-2018.

The institute claimed the residency test should be revised as SMSFs could easily fail the ‘Australian superannuation fund’ test within section 295-95(2) of the Income Tax Assessment Act 1997 and the ATO had no discretion to ignore any failures.

“The test needs to be made more appropriate for SMSFs as the current tests are difficult and have no flexibility if breached,” the letter stated, adding funds that failed the test were discouraged from re-complying through a tax penalty regime.

“If an SMSF is rendered non-complying as a result of failing the ‘Australian superannuation fund’ test, there is a further tax penalty on such a fund gaining its ‘Australian superannuation fund’ test residency back. Accordingly, there is no incentive for such a fund to resume to be an ‘Australian superannuation fund’.”

The institute suggested that if the residency test was not removed, alternative steps could include removing the residency test from the definition of a complying superannuation fund.

Instead, the test could become an operating standard overseen by the ATO, which would determine the appropriate consequence for any breach of the standard, but the institute noted policymakers would have to determine what actions by SMSF trustees the residency test was attempting to address.

A second solution was to remove the ‘central management and control’ test and replace it with a requirement that 50 per cent or more of the trustees, or board of directors of the trustee company, must be Australian tax residents, and to drop the contribution/active member test.

“There appears to be no logical policy rationale for the automatic cessation of compliance status if a fund becomes a non-resident,” the institute noted.

“Given that the active member test really only impacts SMSFs, as a non-resident could still contribute to a large APRA (Australian Prudential Regulation Authority) fund, the policy can’t be based on preventing non-residents contributing to the Australian super regime.”

In August, the SMSF Association also called for the end of the residency test citing the impractical nature of its application to trustees, while in February of this year the Institute of Public Accountants called the test outdated and inconsistent with global work practices.

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