Establishing your SMSFs with individuals acting as trustees may save a few dollars in the short term, but the benefits of registering a corporate trustee for your new SMSF can far outweigh the short-term savings.
This paper outlines seven key reasons for establishing SMSFs with a corporate trustee.
Reason 1 – Succession upon death
A company is an indefinitely continuing entity. Consequently, having a company as trustee for the Fund ensures that control of the SMSF is always certain—an especially important factor when a member of the SMSF dies.
Example:
John and Mary, members of their SMSF, are individual trustees of the Fund. John dies, leaving Mary as the sole remaining member and individual trustee.
For the SMSF to remain compliant, Mary must appoint a second trustee.
Mary, at some stage¹, will need to appoint another person to act as an individual trustee, meaning she will relinquish complete control of the Fund.
The above scenario may have several outcomes. Mary may have children that she wishes to appoint as trustees of the Fund, so documentation to appoint the children as members and trustees of the SMSF would be required to be completed. She would also have to change the name in which all of the Fund’s assets are held.
If Mary does not have any children or close relatives that she trusts to share control of her Fund, Mary may decide to establish a corporate trustee company and act as the sole director to ensure she retains complete control of the SMSF.
In this scenario, she would need to establish the company and prepare relevant documentation to change the trustee of the Fund and the name in which all the Fund’s assets are held.
Had John and Mary established the SMSF with a corporate trustee in the first place, none of the above would have been an issue.
After his death, John’s benefits would be dealt with and Mary would continue as the sole director of the corporate trustee and sole member of the Fund without having to appoint another trustee, prepare any change of trustee documents, or change the name in which the Fund assets are held, all while retaining complete control of the Fund.
Reason 2 – Trustee litigation exposure
Another important reason to have a corporate trustee is litigation exposure. Individuals acting as trustees of an SMSF are jointly and severally liable for any actions taken against the Fund, as they hold the Fund's assets in their individual names. Should litigation against the Fund exceed the assets held in the name of the trustees (i.e., as trustees for the Fund), the individuals' personal assets may become at risk.
Companies, on the other hand, have limited liability. This generally ensures litigation against the Fund is limited:
firstly, to the assets held in the SMSF and
secondly, to the assets held in the company's name.
Liability generally does not extend to the directors of the company. If the company is a sole purpose SMSF trustee company, this will generally ensure any claim against the Fund is limited to the assets held by the company as trustee for the SMSF, with no director’s assets at risk.
The joint and several liabilities of individual trustees were highlighted in the 2011 AAT case regarding the Shail Superannuation Fund. Mr and Mrs Shail were the individual trustees of their SMSF. Mr Shail fled Australia after transferring almost $3.5 million of SMSF money to an overseas bank account. The ATO then assessed the trustees for more than $1.5 million in tax and penalties. As the SMSF had minimal funds remaining, Mrs Shail was personally required to meet the liability.
The above scenario would have resulted in a different outcome had the SMSF trustee been a corporate entity. In that event, Mrs Shail would likely not have been personally liable for the tax shortfall.
Reason 3 – Administrative Efficiency
One of the key benefits of an SMSF is its fluidity - such as allowing multiple generations of a family to come and go from the Fund. Instances of changes in membership to an SMSF may include:
Parents admitting their children into the Fund;
The marriage of an existing member of the SMSF to a non-member of the Fund;
The divorce of members within the Fund;
Upon the incapacity of a member of the Fund, where their Legal Personal Representative is appointed as a trustee of the SMSF in that member's stead or
Upon the death of a member of the Fund, where their Legal Personal Representative is appointed until the death benefits have been paid.
If the SMSF has individual trustees, a change in trusteeship is generally also required whenever a change in membership occurs.
The fact that trustees and members can come and go easily from an SMSF raises a time-consuming and costly administration problem for SMSFs with individual trustees, as the law requires the assets of SMSFs to be held in the names of all of the fund's trustees.
Consequently, whenever a new trustee is appointed to the Fund or an existing trustee leaves the Fund, the Fund is required to notify all relevant registries and offices (and provide a range of documents) to change the name or names under which the SMSF's assets are registered.
Furthermore, legal advice as to the procedures to remove/appoint the trustee and member, as determined by the Fund’s trust deed, must also be sought. Overall, admitting and removing individual trustees can be costly and time consuming.
In contrast, when a new member joins an SMSF with a corporate trustee, the corporate trustee itself does not change; only the company's underlying directorship changes.
The assets are still held in the same name—that is, the name of the company—so there is no need to change the name in which the Fund's assets are held.
Reason 4 - Lump Sum Payments
For an SMSF to receive its concessional taxation status, it must elect to be regulated by the ATO and comply with the laws and regulations outlined in the Superannuation Industry (Supervision) Act 1993 (SIS Act) and Superannuation Industry (Supervision) Regulations 1994 (SIS Regs).
Section 19 of the SIS Act is very specific in its determination of what constitutes a regulated SMSF, effectively stating that the trustee must either be:
a constitutional corporation; or
the purpose of the Fund must be to pay a pension or pensions.
The consequence of this is that if the SMSF has individual trustees, it must have as its sole or primary purpose the payment of old age pensions.
The legislation's effect is that an SMSF with a corporate trustee may pay benefits as either a lump sum or a pension. However, SMSFs with individual trustees must, in the first instance, aim to pay benefits in the form of pensions.
For an SMSF with individual trustees to compliantly pay a lump sum benefit, the member would have to provide a written request to the trustees for the payment to be made as a lump sum benefit.
Reason 5 – SMSF Borrowing
If the SMSF intends to borrow to acquire an asset under the limited recourse borrowing arrangement provisions (LRBAs), lenders may require that it have a corporate trustee.
As a rule, most commercial lenders to SMSFs in relation to LRBAs require that the SMSF has a company as the trustee of the SMSF.
Therefore, an SMSF established with individual trustees may need to go through the process of appointing a corporate trustee and, following that, convert the assets owned by the SMSF into the name of the new trustee of the Fund, should the Fund decide to enter into an LRBA.
Reason 6 – SMSF Administrative Penalties
The Australian Taxation Office (ATO) may apply monetary penalties to trustees of SMSFs in the event of specific breaches of the SIS Act.
If an SMSF has individual trustees, each trustee may be liable to pay the ‘administrative penalty‘.
Alternatively, if the SMSF has a corporate trustee, the penalty is levied on the company (and each director is jointly and severally liable to pay that penalty).
This is explained in examples in the Explanatory Memorandum to the Bill introducing the administrative penalties.
In the examples, an SMSF has contravened section 35B of the SIS Act, which requires the preparation of the Fund's accounts and statements and contains an administrative penalty of 10 units.
The examples indicate that:
with individual trustees, each trustee would be liable for the 10 unit penalty, whereas
with a corporate trustee, the 10-unit penalty would be applied once only (i.e. to be shared amongst the directors).
Reason 7 – Sole Member Funds
If an SMSF with individual trustees has a sole member, the SIS Act requires that the SMSF must have a second individual trustee. This will mean that the sole member will have to relinquish some control over the Fund to another person.
Alternatively, the SIS Act provides that a sole member SMSF can have a company as a trustee with either one or two directors, one of which must generally be the member. In this case, a sole member can assume total control over the SMSF by appointing themselves as the sole director of the corporate trustee.
A sobering thought - the vast majority of SMSFs are established as two member Funds, predominantly with husband and wife as the members. Therefore, the members are not concerned, at that stage, with issues relevant to single-member SMSFs.
However, through death, divorce, or incapacity, those SMSFs are likely to become single-member Funds at some point in the future.
Other Considerations Costs in Establishing a Company as Trustee
Some are put off by the initial cost involved in establishing a company to act as a trustee of the SMSF.
However, the actual costs associated with a sole purpose SMSF trustee company are low compared to the extra costs incurred with individual trustee SMSFs, especially in documenting trustee changes. In addition, if you also consider a company's succession and litigation advantages over individuals, the overall cost-effectiveness will generally outweigh the initial incorporation costs.
In addition, the annual cost of a sole-purpose SMSF trustee company, the ASIC levy, is approximately $50.
Therefore, the ongoing costs are minimal after overcoming the initial registration costs.
Given the above, the money saved by not registering a company as a corporate trustee of the SMSF can prove to be a false economy.
More information
If you have any questions or require more information, please call the team at Crystal Lawyers on 0421 145 637.
¹ Generally, the appointment of an additional individual trustee must be made within six months of commencing to pay benefits following the death of a member.
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