The Super Group has always strongly recommended that SMSFs adopt a Corporate Trustee structure, and I have always been somewhat surprised that an overwhelming majority (75%) of SMSFs do not use this structure. I expected that as the industry matured the use of Corporate Trustees would increase, given the clear cut advantages. So I am really perplexed with recent ATO statistics showing that approximately 91% of newly registered SMSF’s in 2012 had individual trustees.
This is a poor reflection on the level of SMSF knowledge and experience among the accountants and advisers facilitating the establishment of these funds.
The underlying reason seems to be that SMSF establishment and administration by and large remains a highly disaggregated sector. This is starkly illustrated by the statistics for fund lodgements. In 2012, of the 13,029 Tax Agents who completed and lodged SMSF returns, 66% completed fewer than 20, and 94% completed fewer than 100.
Any experienced SMSF adviser should recommend a corporate trustee structure – without exception.
The notion of either a corporate or natural person trustee originates with the introduction of the Superannuation Industry Supervision Act (SIS Act) 1993.
Essential to the Act’s operation were its penalty provisions – breaches would incur either fines or non-compliance notices. To enforce these provisions a legal mechanism was required. That mechanism was found within either the Corporations Act or the Constitution.
Every superannuation fund, including SMSFs, was, and still is, required to have either a constitutional corporation as trustee – to enable the enforcement of penalties via the Corporations Act – or natural person trustees who are obliged to pay age pensions, and thus enable the enforcement of penalties via the Constitution (the pension powers are contained in the Constitution).
When faced with these two options, most aspiring SMSF owners seem to opt for the lowest cost option – natural person individual trustees – without regard to the pros or cons. Hence, 75% of all SMSF’s having individual trustees.
However this is misguided, short term thinking, as the long term benefits of a corporate trustee far outweigh the cost savings at time of set up.
Benefits of a Corporate Trustee
- Avoiding the intermingling of assets
Section 52 of the SIS Act requires Covenants to be included in Trust Deed to the effect that Trustees keep money and other assets of the Fund separate from money and assets personally held by them.
Where a Fund has individual trustees, each fund asset must be registered in both (or all) trustee’s names – without exception.
We know of numerous cases where, through either haste or convenience, only one trustee’s name appears on certain fund asset. Under these circumstances, it would be very difficult to prove adherence to this covenant and would likely result in an audit contravention report. Indeed, 33% of all contraventions relate to not separating fund assets from those of members.
Having a special purpose corporate trustee eliminates this risk as assets would simply be registered in the company’s name.
- Limited Liability
Fund assets are protected from bankruptcy and other personal civil claims.
To enjoy this protection, one must be able to demonstrate or prove that SMSF assets are fund assets and not personal assets. Where assets are in an individual’s name, as is the case with individual trustees, one may have a more difficult task in proving assets are protected fund assets rather than personal assets.
Having assets legally registered in a special purpose trustee company name avoids this risk.
- Re-registering assets when fund membership changes
A condition precedent of all SMSFs is that all members be trustees and all trustees be members (subject to limited exceptions) – Section 17A SIS Act. Therefore, whenever, a member joins or leaves a fund they must also be added or removed as trustee.
Where you have individual trustees this necessarily involves re-registering all fund assets in all trustee’s names. This typically includes closing and opening bank accounts, updating managed fund records and amending registry holdings for listed investments (for which most brokers charge around $55 per equity). This is an administrative burden and an expensive exercise.
Having a special purpose corporate trustee avoids this. When members join or leave, all that is needed is their appointment or removal as an office holder (director) of the company. Assets do not need to be re-registered and bank accounts need not be changed.
- Estate Planning
Following on from the above, the benefits of a Corporate Trustee are particularly apparent when a member dies. If a fund were to have individual trustees and a member (trustee) were to die, then any remaining assets (after paying out the death benefits) would need to be re-registered in the new trustees’ names. The same goes for any bank accounts.
Moreover, death benefits are not governed by the deceased member’s Will. Death benefits are dealt with at the discretion of the trustee, subject to any reversionary pension or binding death benefit nominations. Therefore, the person who becomes trustee upon the death of the member is important, particularly if they are free to exercise their discretion.
With a special purpose corporate trustee, not only can special death benefit conditions be written into the company’s constitution but the way company shares are dealt with upon death can be governed by the deceased’s Will. Shares in the trustee company are personal assets of the member and not trust assets, and are therefore subject to the Will. Thus the Will could require, for example, that the shares be gifted to the intended beneficiary of the death benefits. That beneficiary, upon receiving the shares, could appoint themselves, by shareholder resolution, as a director of the company and thus exercise their discretion to pay death benefits to themselves.
- Single Member Funds
Where you have a single member fund the law requires you either have two individual trustees or a corporate trustee, where the member is one of two directors or the sole director. In this latter case, the fund would have one member and one director.
Let’s look at the example of the death of a member of a two member fund. If the fund had two individual trustees and a member was to die, the fund would become a single member fund and be required to either appoint another trustee or convert to a corporate trustee.
The appointment of another trustee could be challenging. You would need to find someone you could trust, as assets would be co-registered in their name, and ultimately they may be required to decide to whom and in what proportions to pay the remaining member’s death benefit (subject to any binding nominations or reversionary pensions).
If, however, that same fund had a corporate trustee, none of this would pose a problem. Upon the death of the member, the fund would become a single member fund where that member is the sole director. That member would also retain the option to appoint a second (non-member) Director should that facilitate estate planning arrangements.
- New Penalty Provisions
From 1 July 2014, the ATO has been given new powers to impose administrative penalties for certain SMSF compliance breaches. The penalties range from $850 to $10,200 per breach and are payable by the person(s) who had committed the breach. They cannot be paid or reimbursed out of the fund.
Where you have a breach with individual trustees, each trustee is deemed responsible for the breach. Each will therefore have a fine imposed. This has the effect of multiplying the fine by the number of members.
If, however, the fund had a corporate trustee, because each director is jointly and severally liable only one penalty is applied to the company.
- Wholesale Client
The status of a Wholesale Client has been in the press recently following ASIC’s withdrawal of QFS 150.
Being a Wholesale Client may entitle one to products and services not generally available to retail clients. For example, some investment banks require their clients furnish a Wholesale Client certificate before being eligible to join their “private client” platforms.
Prima facie, a trustee of an SMSF will be considered a wholesale client where the fund has net assets of a least $10 million. However, the Corporate Regulations appear to pave a way for an SMSF to satisfy this test where it has net assets of less than $10 million. That pathway is commonly referred to as the Controlling Entities test.
Specifically, where an individual controls an SMSF, that SMSF will be treated as a wholesale entity if the “controlling individual” personally meets the wholesale test. That test being that the person has net assets of at least $2.5 million or a gross income in the last 2 financial years of at least $250,000.
The relevant question, therefore, is one of control – what defines a controlling individual?
A trust (fund) is regarded as “controlled” by a person if that person has the capacity to determine the outcome of decisions about its financial and operating policies. However, it does not include the situation where that person and another person jointly have the capacity to determine those outcomes.
Where you have individual trustees, neither trustee can control the trust. It therefore would appear to be impossible for a fund with individual trustees to be treated as a wholesale client unless it has net assets of at least $10 million.
There is no doubt that a Corporate Trustee structure is the superior option for SMSFs, if only for the administrative ease in the virtually inevitable event of a change to a fund’s membership.
The Super Group can provide a Corporate Trustee upgrade service for your fund, including if required facilitating the re-registration of fund assets. Please feel free to contact us if you are interested in this service.