Self-managed super funds (SMSFs) are a way of saving for your retirement. The difference between an SMSF and other types of funds is that the members of an SMSF are usually also the trustees. If you set up a self-managed super fund (SMSF), you make the investment decisions for the fund and you're held responsible for complying with the super and tax laws. It is a major financial decision and you need to have the time and skills to do it. There may be better options for your super savings. An SMSF must be run for the sole purpose of providing retirement benefits for the members or their dependants. Do not set up an SMSF to try to get early access to your super, or to buy a holiday home or artworks to decorate your house. These things are illegal.Setting up Your self-managed super fund (SMSF) needs to be set up correctly so that it is eligible for tax concessions, can receive contributions and is as easy as possible to administer. To set up an SMSF you need to: • Consider appointing professionals to help you • Choose individual trustees or a corporate trustee • Appoint your trustees • Create the trust and trust deed • Check your fund is an Australian super fund • Register your fund and get an ABN • Set up a bank account • Get an electronic service address • Prepare an exit strategy Contributions and rollovers As an SMSF trustee, you can accept contributions and rollovers for your members from various sources but there are some restrictions, mostly depending on the member’s age and the contribution caps. You need to properly document contributions and rollovers, including the amount, type and breakdown of components, and allocate them to the members’ accounts within 28 days of the end of the month in which you received them. From 1 October 2021, to rollover any super to or from your SMSF, you will need to use SuperStream. Paying benefits Generally, your SMSF can only pay a member's super benefits when the member reaches their ‘preservation age’ and meets one of the conditions of release, such as retirement. The payment may be an income stream (pension) or a lump sum, depending on the circumstances. Payments of benefits to members that have not met a condition of release are not treated as super benefits – instead, they will be taxed as ordinary income at the member's marginal tax rate. If a benefit is unlawfully released, ATO may apply significant penalties to you, your SMSF and the recipient of the early release. Winding up To wind up your fund: • complete any requirements that the trust deed specifies about winding up the fund • pay out or rollover all super (leaving a sufficient amount to pay final tax or expenses if required) • appoint an SMSF auditor to complete the final audit • complete and lodge the final SMSF annual return (including wind up details) • pay any outstanding tax • after all expected liabilities have been settled and requested refunds are received, close the fund’s bank account. • Once a fund is wound up, it can’t be reactivated. This article is for informational purposes only and does not form part of our advice. This article is based on Australia Taxation Office guideline. Please contact our team if you need any assistance.
Beneficiaries Most trust deeds of discretionary trusts will list the primary beneficiaries of the trust being those persons (or entities) specifically named in the trust deed as the objects (i.e. potential beneficiaries) of the trust. As a corollary the general beneficiaries of a trust are those entities or class of entities who are potential eligible beneficiaries based on their relationship to the primary beneficiaries under the trust deed. Accordingly, if a husband-and-wife are the sole primary beneficiaries of a trust, any company or trust under which they may potentially benefit may be regarded as a general beneficiary based on their relationship with such primary beneficiaries if the definition of general beneficiaries under the trust deed is based on this association. Distributions by the trusteeThe trust deed should also be reviewed to identify the specific clauses which empower the trustee to distribute trust income to beneficiaries, and which set out what the trustee must do in order to make a beneficiary presently entitled to a share of trust income by the required time. Compliance with such a clause is critical as an object (i.e. potential beneficiary) of the trust only obtains a vested and indefeasible right to a distribution upon the trustee validly exercising their discretion under the trust deed to appoint them as a beneficiary. Hence, the trustee’s distribution resolution should include references to the relevant clauses identified under the trust deed which grant the power to the trustee to make a beneficiary presently entitled to trust income. Tax Impacts of Potential Distributions Upon identifying the range of potential beneficiaries, the trustee will in practice be required to consider the tax impacts that a distribution of trust income may have on the trust or beneficiaries from an income tax perspective. In particular, the trustee will need to take into account certain restrictions that are effectively placed on the making of distributions to particular beneficiaries from an income tax perspective which may limit the nature of the distribution made or the amount of tax payable on such a distribution. For example, the trustee may distribute certain amounts of trust income or capital to particular beneficiaries so that the discretionary trust can satisfy the pattern of distributions test or the 50% stake test in recouping prior year tax losses. In addition, a trustee of a discretionary trust may also make a distribution of 20% or more of trust income and/or capital to a particular beneficiary in the year that the trust has made a capital gain so that beneficiary is regarded as a significant individual for the purposes of the discretionary trust claiming the 15 years exemption or the retirement exemption under the Capital Gains Tax (CGT) small business concessions. However, the three major restrictions imposed under the income tax law on the making of such distributions comprise the following: 1. The proportionate approach which places limits on the capacity of the trustee to engage in income splitting amongst the beneficiaries. 2 The limits placed on the definition of the income of the trust estate under Draft Taxation Ruling TR 2012/D1 which provides that trust income cannot include ‘notional amounts’ that are only recognized for income tax purposes.3 The existence of a family trust election which would deter a trustee from making a distribution of trust income (and therefore related net income) to a beneficiary who is outside the family group which would be subject to punitive family trust distribution tax. Proportionate Approach The trustee makes a beneficiary presently entitled to a share of the income of the trust estate (being the distributable income calculated in accordance with the trust deed) under section 97(1) of the ITAA (1936) that beneficiary will be assessed on an equivalent share of the trust’s net income (being the trust’s taxable income as calculated under section 95(1) of the ITAA (1936)). Accordingly, where a beneficiary becomes presently entitled to, say, 50% of the income of the trust estate (as reflected in the distributable income shown in the trust’s accounts) that beneficiary will be proportionally entitled to 50% of the net income of the trust for tax purposes (as disclosed in the trust’s tax return). The application of this proportionate approach effectively precludes the trustee from distributing specific amounts of trust income to particular beneficiaries based on a ‘quantum’ approach as once the fractional interest of the beneficiary to trust income is determined the beneficiary will be presently entitled to an equivalent fractional share of the trust’s net income. Thus, once the percentage share of trust income is set there is no capacity to further income split the resulting net income amongst the beneficiaries. Limits on trust income for ‘notional amounts’ Determining the amount of the income of the trust estate for the year is vital to the process of establishing the proportionate share of net income upon which presently entitled beneficiaries will be assessed. Whilst acknowledging that the income of the trust estate will be based on the definition of that term contained in the trust deed, the Commissioner of Taxation has also taken the view in Draft Taxation Ruling TR 2012/D1 that ‘notional income amounts’ which are only recognised for income tax purposes cannot constitute income of the trust estate for trust law purposes. In reaching this view, the ATO contend that there is a statutory limitation on the meaning of income of the trust estate imposed under Division 6 of the ITAA (1936) in that income of the trust must represent a net accretion (i.e. increase) to the income derived by the trust during a particular year which is distributable to beneficiaries. This will be the case irrespective of how the particular trust deed otherwise defines income of the trust estate. As such, this approach essentially places a cap on the amounts of income which can otherwise be included in trust income to which beneficiaries may be made presently entitled. The rationale for the above view is that notional amounts of income which arise in the calculation of the trust’s net income for a particular year cannot represent a net accretion (i.e. increase) to trust income as they are ‘tax-only’ amounts which do not represent any tangible net increase in the value of trust property for that year. Hence, if the trust deed includes an income equalisation clause which defines trust income as being the net income of the trust for a particular year the ATO view is that such trust income must exclude notional tax-only amounts. Such notional income amounts will include, amongst others, franking credits, deemed dividends arising under Division 7A of the ITAA (1936) and a capital gain arising because the operation of the market value substitution rule where no capital proceeds are received on the disposal of an asset. Distributions made outside the family group
A further important issue for a trustee to consider when contemplating a distribution of trust income to a particular beneficiary is whether the trust has previously lodged a family trust election. To recap a family trust election is a one-off election made in writing by the trustee of the trust nominating that the trust will be treated as a family trust albeit only for certain purposes of the income tax law. In particular, the lodgment of a family trust election will: • Simplify the rules that must be met by a trustee of a discretionary trust in recouping trust losses; • Enable a subsidiary company of such a trust to trace its beneficial ownership for the purposes of satisfying the continuity of ownership test in recouping its tax losses; and • Retain a beneficiary’s entitlement to use franking credits on franked dividends distributed by the trustee of the discretionary trust where the 45 days holding period rule cannot otherwise be satisfied. Where such an election has been made a test individual will have been nominated which will establish the members of the family group as the identity of all eligible family members will be determined by reference to that primary individual. However, where a distribution is made to a particular beneficiary who is outside the test individual’s family group such a distribution will be subject to family trust distribution tax which is levied at the highest effective marginal tax rate being currently 47%. Thus, a trustee of a discretionary trust must exercise caution so that a distribution is not made to a person or entity which would be eligible to receive such a distribution under the trust deed where that beneficiary is not also a member of the elected family group. Where such a distribution is made it will be subject to family trust distribution tax at the above punitive rate of 47%. This article is for informational purposes only and does not form part of our advice. Please contact our team if you need any assistance. Claire Chang, 0497 131 419, firstname.lastname@example.org, wechat: clairechang26 Michelle Cui, 0433 539 870, email@example.com, wechat: michellejc
Where an individual carries on business as a sole trader or as a partner in a partnership, they are held personally liable for debts incurred while carrying on the business (as well as personal income tax liabilities). As such, the ATO does not require special collection powers to hold principals liable for taxation liabilities incurred by sole traders or individual partners. A similar outcome applies where an individual acts as the trustee of a trust that carries on business (although the individual trustee has a right to be indemnified out of trust assets). On the other hand, where a business is being carried on by a company (including a company in its capacity as trustee of a trust or as a partner in a partnership), the director penalty notice (‘DPN’) rules contained in Division 269 of Schedule 1 to the TAA 1953 may apply to make company directors personally liable for the following taxation liabilities of the company (in circumstances of non-payment by the company): • PAYG withholding amounts; • superannuation guarantee charges; • net GST liabilities (including luxury car tax and wine equalization tax); and • estimates of the above liabilities. Previously, the Commissioner could only issue a DPN in respect of PAYGW and SGC. However, with the Treasury Laws Amendment (Combating Illegal Phoenixing) Bill 2019 having received Royal Assent on 17 February 2020, the Commissioner now has the power to issue a DPN to recover unpaid GST. Note that the legislation refers to an “assessed net amount” for a tax period, which not only includes the net amount of GST (i.e., GST less input tax credits) but also includes Luxury Car Tax (‘LCT’) and Wine Equalisation Tax (‘WET’). GST instalments are also included. Directors must also be mindful of providing personal guarantees for the company, which reduce the level of asset protection offered by the company, as personal guarantees directly place the directors’ personal assets at risk in the event of the company’s failure. Section 269-15(1) provides that the directors’ obligation commences on the ‘initial day’ for the relevant amount. The ‘initial day’ is: • for PAYGW – the day the company withholds the amount • for SGC – the last day of the relevant quarter (e.g., 31 March, 30 September); or • for estimates – the day the estimate was due and payable (note that this has been changed to (generally) the last day of the period to which the estimate relates, as discussed below). The expanded DPR applies to: (a) net amounts and assessed net amounts for tax periods that start on or after 1 April 2020; and (b) GST instalments for GST instalment quarters that start on or after 1 April 2020. The estimates regime has also been expanded so that the Commissioner can now make an estimate of a net amount of GST (or LCT or WET) that has not been assessed. An estimate can be made in respect of the tax periods noted above. The directors’ obligation remains in place until such time as the company complies with its obligation (to pay the relevant amount to the Commissioner) or, alternatively, an administrator or a small business restructuring practitioner is appointed, or the company commences to wind-up. If, at the end of the ‘due day’, the directors are still under their obligation to ensure the company pays an amount to the Commissioner (i.e., none of the things mentioned above have happened), then any person who was a director at any time (even for one day) during the period commencing from the ‘initial day’ and ending at the ‘due day’ is liable to pay the Commissioner a penalty equal to the unpaid amount of the company’s liability under its obligation. The penalty is due and payable at the end of the due day. If a person ceased to be a director before the ‘initial day’ for an amount, they will not be liable for a penalty in relation to that amount. However, it is important to note that, if a person becomes a director after the ‘due day’, and none of things referred to above have happened 30 days later, they will be a liable for a penalty. The penalty is due and payable at the end of the 30th day. What if a director resigns during the 30 days period? It is crucial to note that, even if a person is appointed as director after the due day but then ceases to be a director before the 30 day ‘grace period’ is up, they will still become liable for a penalty.
Recovery of penalty
To recover the penalty, the Commissioner must give a notice (referred to as a ‘Directors Penalty Notice’ or ‘DPN’) to each director setting out the amount of the unpaid liability of the company, as well as the ways the penalty can be remitted. The Commissioner must then wait 21 days before he can commence recovery proceedings. However, the Commissioner cannot take recovery action if a payment arrangement is in place under S.255-15. It is important to note that a DPN is taken to be given at the time the Commissioner leaves it or posts it. That is, the 21 days starts from this time and not from when the director receives the DPN. Remission of penalty A director’s penalty will be remitted if the directors cease to be under their obligation before the end of the 21-day period. This will only be the case where an administrator or a small business restructuring practitioner is appointed, or the company commences to be wound up in that 21-day period. Lock-down penaltiesIn some cases, a director’s penalty is ‘locked down’. This means that, if the company does not notify the Commissioner of the amount of its liability within 3 months after the ‘due day’, there is no course of action that can be taken to cause the penalty to be remitted, i.e., it is ‘locked down’. For example, if the 3 months has passed without notification having been made, appointing an administrator, or commencing to wind-up the company will not cause the penalty to be remitted. Despite the above, there are some limited circumstances in which a director will not be liable for a penalty, as follows: • if, because of illness or for some other good reason, it would be unreasonable to expect the person to take part, and they did not take part, in the management of the company at any time they were a director; • the person took all reasonable steps to ensure the company complied with its obligation, appointed an administrator or a small business restructuring practitioner, or wound up (or there were no reasonable steps they could have taken to ensure any of those things happened); or • in the case of SGC, the company took a position that was reasonably arguable. The onus is on the director to prove the relevant matters for a particular defence. Whilst the facts and circumstances vary for each director, directors arguing a defence before the Courts have typically been unsuccessful in the past. This article is reference to ATO’s Director Penalty Notice and other related articles. This article is for informational purposes only and does not form part of our advice. Please contact our team if you need any assistance. Claire Chang, 0497 131 419, firstname.lastname@example.org, wechat: clairechang26 Michelle Cui, 0433 539 870, email@example.com, wechat: michellejc