Over the past few months, Cuffelinks has received many questions from readers in response to articles covering powers of attorney, enduring guardianship, succession planning and limited recourse borrowing arrangements (LRBAs) within an SMSF. We asked Liam Shorte of Verante Financial Planning to provide some answers, which have been collated here for easy reference.
Ross: Can a corporate trustee of an SMSF execute a Power of Attorney which is limited to only take effect after the death of the sole member/director/secretary?
Liam: An Enduring Power of Attorney is not valid in this case as it terminates after the death of the donor. The deceased person’s Legal Personal Representative is the one who may take control in the case of death subject to the constitution of the corporate trustee and trust deed but there can be complications. Accordingly, it is often recommended that either another director be appointed from the outset to act alongside the sole member, or the company trustee appoints someone as the company’s attorney, so that this person can act on behalf of the company if the member dies.
In terms of managing the risk of mental or physical incapacity then you can use an Enduring Power of Attorney and prescribe the instances under which that power is activated such as “on loss of mental capacity as confirmed by two specialists”. This option is becoming more common as the values of SMSF balances increase, dementia and Alzheimer’s cases grow more prevalent and elder financial abuse cases are on the rise.
Wayne: Is it possible for an SMSF corporate trustee to have three directors but only two members with the third director being a non-member?
Liam: The answer is no, I am afraid. The rules are that all trustees must be a member except in single member funds. For SMSFs other than single member funds, an SMSF is one where:
- there are four or less members
- all members are trustees, or directors of the trustee company
- there are no trustees or directors who are not members
- there are no members who are employees of other members (unless they are relatives).
It may be prudent to have a trust deed and company constitution that allows for the automatic appointment of a Legal Personal Representative/Executor as a company director on death of a member. An alternative in funds where voting power is based on balances is for the third director to have a small balance and the main two directors still control the fund with majority voting rights.
Ryan: If a property with development potential was purchased under a LRBA and then the loan was paid off over many years, can the house then be developed assuming one has the cash to do so?
Liam: Yes it may be possible to develop the property but there are pitfalls to be aware of in entering development contracts where the SMSF is involved. An SMSF trustee is prohibited from giving a charge over assets of the fund so the venture could not have an overdraft or credit facilities with suppliers where their terms commonly include a lien or charge over fund assets. Likewise many building contracts include clauses that provide protection for the builder by way of a charge over the customer’s assets or an encumbrance preventing the SMSF trustee dealing with the land and again these would both contravene regulation 13.14 of the SIS Regulations.
The big question is: Is the SMSF trustee engaging in the business of property development?
A widely-held view is that a fund trustee cannot operate a business as it would be inconsistent with the sole purpose test. This is a common misunderstanding - the sole purpose test does not necessarily prohibit a fund trustee carrying on a business. It merely requires a fund to be established and maintained for the purpose of providing retirement benefits to members and/or death benefits to members’ dependants.
The ATO has stated that 'if a superannuation fund is conducting a business, then it is not being administered for the sole purpose of providing benefits for the members and beneficiaries of the fund’ (NAT 2061). However, an SMSF trustee will not necessarily be carrying on a property development business just because it develops land. The nature and scale of the development, and whether the land once developed will be held or sold, will determine whether a business is being operated.
The Commissioner stated in SMSFR 2009/1 that the usual investment activities of a trustee will not be considered as carrying on a business, which could include developing vacant land. Thus the development of land may simply be the realisation of a capital asset. If the land development is likely to satisfy the requirements of a business, the fund trustee should ensure that the activities being carried out comply with the provisions of the Superannuation Industry (Supervision) Act 1993 (SIS Act) and in particular, the sole purpose test.
For the ATO’s current view, see Carrying on a business in an SMSF.
In summary, it may be possible but seek personal legal and tax advice and also consider alternative structures such as an Ungeared Unit Trust for the development.
Liam Shorte is a specialist SMSF advisor and Director of Verante Financial Planning. These responses are for general information only as the full circumstances and context of the questions is not known. Professional personal financial advice should be sought before taking action.