Residency of Super Funds - Active Member Test

Australian residency for a superannuation fund is a precondition for the superannuation fund qualifying as a complying superannuation fund.  While the same definition of “Australian superannuation fund” applies to both SMSFs and non-SMSFs, its application to SMSFs can have a disproportionate impact on SMSFs compared to non-SMSF funds.

When a single SMSF member becomes a non-resident it profoundly affects the residency status of an SMSF.  While a single member of a retail fund or a industry fund becoming non-resident is likely to have no impact on the residency status of that fund, as the non-resident member is simply overwhelmed by the other resident members of the fund.

For taxation purpose a super fund will be an Australian superannuation fund if the fund satisfies three tests.  If the fund satisfies all three tests at any time during the financial year, the fund will be an Australian resident fund for that financial year.  For example, a fund could satisfy two of the three tests at all times during the financial year, but only satisfy the third test on the last day of that year.  In this case, the fund will qualify as an Australian superannuation fund.

For SIS purposes, it is a precondition for a fund to qualify as a complying superannuation fund that it be at all times during the financial year, a resident regulated superannuation fund.  The fund will be a resident regulated superannuation fund if the fund is at all times during the financial year, an Australian superannuation fund and also a regulated superannuation fund.  Where the fund was established part way during a financial year, the fund must be a resident regulated superannuation fund at all times during the financial years when it was in existence.

The difference in treatment for tax and SIS purposes can be explained because tax and SIS are intended to achieve different policy objectives.  For tax purposes, the desire is to have the net as wide as possible due to the fact that if a super fund qualifies as an Australian superannuation fund for even only one day of a financial year, this permits the ATO to tax the fund’s entire world wide income.  However, for SIS purposes the net is to be as narrow as possible, because the tax concessions applying to super funds are to be kept as tightly controlled as possible.

Consequently, when considering the impact of a member of an SMSF becoming non-resident, the relevant test is whether the SMSF is at all times an Australian superannuation fund.

For the fund to be an Australian superannuation fund at all times during a financial year all three tests must be satisfied at all times.  In practice, this means determining whether any time during a financial year whether any of the three tests were not satisfied.

The three tests are the nexus test, the central management and control test and the active member test.  This article will focus on the active member test. 

The active member test will be satisfied at all times during the financial year if either:

• the fund had no active members at all during that financial year or,
• if the fund has one or more active members at any time during the financial year - the aggregate of the member balances of the non-resident active members must be less than the aggregate of the member balances of all resident active members.

A member is an active member in a financial year if a contribution to the fund has been made for or by them during that financial year.

The best solution to handle a member becoming non-resident during a financial year (apart from the nuclear options of winding up the fund, transferring the member out of the fund or converting the fund to a small APRA fund) is to ensure that no contributions are made by or on behalf of the non-resident member to the fund during any financial year a member is a non-resident.  In this context “contributions” probably includes benefit transfers and rollovers from other funds and not merely money entering into the super system.  Additionally, “deemed contributions” in respect of the member should be avoided.

However, contributions could still be made in respect of a non-resident member if the non-resident member’s balance is less than the aggregate of the balances of the resident active members.  For this to occur it may be necessary to ensure that each resident member is counted as an active member by having at least a small contribution being made for them.  In fact the small contribution could be made by the non-resident member for the resident member.  However there is a significant risk with this strategy.

The risk with making contributions for a member while a non-resident, is that it requires the member balances of the resident active members to be at all times greater than the member balance of the non-resident member.  

What would happen if one of the resident active members were to exit the fund during the financial year? Consider a fund with three members, A, B and C.  A is the non-resident member and has a member balance of $100,000 while B and C have member balances of $60,000 and $50,000.  All three members are active members.  A could still make contributions to the fund as his member balance is less than the combined member balances of B and C.  Now if C were to exit the fund during the financial year, A’s member balance would (from the time of exit of C) be greater than the remaining resident members’ balance.  From that time on the fund would have failed the “active member test”. As the fund has failed the active member test for one day, the fund cannot qualify as a resident regulated superannuation fund and therefore has lost its compliance status.

Another risk with this strategy is that the contributions made for the non-resident member (and/or benefits paid to the resident members) may disrupt the relative balance between the resident and non-resident members.  Consider the further development of the previous example, where A makes a $30,000 contribution during the financial year and B and C each make a $1,000 contribution.  At some point during the financial year, A’s member balance will be $130,000 while the combined balances of B and C will be $112,000.  Once A’s balance exceeds the other balances, the fund will have failed the active member test and the fund will therefore cease to qualify as a complying superannuation fund.

Conclusion – while it is possible to take advantage of the active member test to permit a non-resident member to make contributions after becoming a non-resident, this strategy is subject to a number of key risks – such as a resident member exiting the fund during the financial year or the lower balances of the non-resident members becoming (either by additional contributions, benefit payments or a previously resident member becoming non-resident) the dominant member balance.