Many people are encouraged to think that their super fund is much like a bank, where they deposit money, earn interest and draw the money out when they retire.
That is a mistake because super funds are nothing like banks. A super fund is structured as a trust. A trust is legal entity that means someone holds property or assets (e.g. money, shares or real estate) for the benefit of someone else. As I am not a lawyer, what follows is a layperson’s understanding of the topic.
A primer on trusts
A trust is established when someone settles some assets under the care and control of someone who is appointed to manage the assets on behalf of and for the benefit of someone else. If I give you $1 million to care for my children while I undertake a hazardous mission, we have established a trust. I am the settlor, you are the trustee with a special responsibility, and my children are the beneficiaries of this arrangement. We will need to establish a trust deed which sets out the rules under which the trust will operate and what the trustee can and cannot do. This is a legal document, enforceable through the courts. Trust law goes back to the time of the Crusades.
As the trust is a separate legal entity, ownership becomes a really interesting question. Using the example above, I am no longer the owner of these assets as I have gifted them to the trust. My children don’t own these assets either, because they are underage. The trustee doesn’t own these assets because they are merely the custodians and managers of the assets on behalf of my children. To get around the problem, the trustee is considered the legal owner and must complete the tax return on behalf of the trust, but my children are the beneficial owners and collect the income and ultimately, the capital from this trust.
A good example is the way family trusts used to be a great place to hide assets when it came to the age pension. If you didn’t own these assets, those assets couldn’t be counted in the assets test and thus reduce your pension. The law was changed in 2002 to allow Centrelink to look inside a family trust. This law does not establish ownership but determines control of the fund and the source of these assets. If you control the assets in the trust or those assets came from you, all the assets in the trust are considered to be yours for the purposes of the assets test.
There are many different types of trusts. They are particularly useful in making provision for beneficiaries who cannot manage their own affairs, such as children with disabilities. Some trusts are established in your lifetime; others can be established in your will to take effect on your death. Nevertheless, all trusts follow the same principle: assets are managed on behalf of beneficiaries by a trustee.
All superannuation funds are a specific type of trust. That includes industry super funds and self-managed super funds. They all operate under the same superannuation law. Industry super funds are somewhat opaque in that regard as most people would have difficulty in identifying the trustee of their fund. With SMSFs, however, the issue is very real. The fund must have a trust deed and the decision to use personal trustees, or a company (corporate) trustee needs serious consideration.
Super funds are trusts
Because a super fund is legally structured as a trust, not a company or a bank, as a member, I am not an owner nor a shareholder. It means that I do not ‘own’ my wealth held in my super fund. It is merely held ‘in trust’ on my behalf as a beneficiary of the trust. Special laws were required to give the Family Court powers to split superannuation benefits in the case of divorce.
My status as a beneficiary, rather than an owner, has many implications. I do not elect trustees, and I cannot influence trustee decisions. Those assets do not become mine until released by the trustee. The distribution of my super benefits on my death is determined by the trustees, not by my will, because my will can only deal with the assets I actually own.
It also means that with a two-member SMSF, there needs to be special arrangements to ensure there is a trustee in place to make that distribution of super benefits on the death of the second member, otherwise there is no one with authority to operate the fund.
It is the fact that I do not own these assets that puts them beyond reach of creditors in the case of bankruptcy. In an SMSF, all members are trustees and all trustees are members but that does not change the legal relationship between members and the assets in the trust. One common mistake that SMSF trustees make is to regard the fund assets as their own so that they use the SMSF bank account for temporary personal loans. But they forget that any withdrawal from that bank account is a pension or lump sum payment from the fund and any deposit is a contribution governed by the contribution rules.
Most importantly, a super fund is a separate entity for tax purposes with its own tax file number (TFN). That is why, until now, ALL tax payable in superannuation on both contributions and fund earnings are paid by the fund, not the individual member. The proposed Division 296 tax changes, however, will mean that I, as a member, become responsible for the tax liability on the income and capital gains of another tax entity – the super fund.
Issues with the $3 million super tax
Div 296 is not a tax on super funds – it’s an individual tax liability – but it’s a tax based on the growth in assets that I do not own! I do not own the assets in my super fund held in a trust on my behalf. So how can I be held responsible for the tax on these assets?
How can I be responsible for the tax liability of another taxpayer?
Jon Kalkman is a former Director of the Australian Investors Association. This article is for general information purposes only and does not consider the circumstances of any investor. This article is based on an understanding of the rules at the time of writing and anyone considering changing their circumstances should consult a financial adviser.