Reserve removal must be fair

SMSF reserves

Fairness is a criteria that needs to be observed when looking to allocate monies tied up in reserves across all members of an SMSF.

An SMSF expert has reminded advisers and trustees that the strategy of extinguishing residual reserves by admitting new members to a fund and allocating monies to them must be executed fairly as dictated by the Income Tax Assessment Regulations.

The warning comes amid suggestions individuals of a similar demographic to the member associated with the original reserve, such as brothers, sisters and cousins, be introduced to an SMSF to facilitate the elimination of reserves no longer required like those arising from legacy pensions.

“Certainly bringing other people in for the purpose of potentially allocating the balance of reserves [has merit]. But of course the issue you’ve got is as soon as you allocate unfairly to one person, [you have to determine] have you actually broken the requirement that [the reserve needs to be allocated fairly] and therefore any allocation to the others is fully assessable against their concessional cap?” BDO Adelaide senior consultant Peter Crump told delegates at the recent SMSF Association Technical Summit 2022 on the Gold Coast.

“I think you do and therefore they don’t have the concession of 5 per cent of their balance.”

According to Crump, when looking to implement a strategy like this, many factors relating to the individual’s unique circumstances must be taken into account.

“[You have to] look at their concessional cap, have they got capacity to exceed their cap, do they have tax problems; there are all of these thought processes [that need consideration] as to who can we co-join to the fund,” he said.

Further, if the ultimate aim is for the excess reserve amount to be returned to the member who was the beneficiary of the legacy pension in question, then the trustworthiness of the person being brought into the SMSF has to be assessed carefully.

To this end, Crump suggested it would be inappropriate to include children in a reserve-extinguishing strategy of this nature.

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