Double trouble for SMSF trustees in US

DIY fund members overseas can face punitive consequences from the ATO but could face extra tax if they’re in America.

Peter TownsendContributor

Self-managed super funds can be terminated by COVID-19 if trustees are caught overseas and cease to be Australian residents or effectively move the “central management and control” of the fund offshore with them. In situations like this, the fund ceases to be an Australian super fund and loses its tax concessions.

There have, however, been some interesting developments since the issue was first highlighted after becoming a problem for more people because of the impact of COVID-19.

The first is the decision by the Commonwealth government in the recent budget to extend the grace period to five years from two years. This means that the trustees can be temporarily overseas for up to five years and yet the fund can still retain its character as an “Australian” fund. This is good news for trustees caught overseas by Australia’s border closure, or working or studying offshore.

But beware – if the trustees indicate they have moved permanently overseas, the five-year grace period does not apply. Once the move is permanent, the trustees cease to be Australian residents and the fund is no longer “Australian”.

The new five-year rule hasn’t come in yet and no one knows exactly when it will. So some care is necessary as to precisely when it can be relied upon.

The other issue of interest relating to people stuck in the United States was highlighted by Peter Bowers, an Australian expat living there. He points out that American tax law considers you a US resident if you’ve been there for 183 days, and thereafter you are subject to US tax. This could include your SMSF, which the US has no equivalent of and therefore can treat any way it likes.

And so we come to the story of Alan Dixon who found this out the hard way; he is the son of Daryl Dixon who established the SMSF one-stop shop called Dixon Advisory.

Alan set up a real estate company in the US and Dixons (later Evans Dixon) invested client money in the business. Alan became a resident of the United States.

In August 2020, Dixon disposed of all his shares in Evans Dixon that were held through his Australian private company for about $18.6 million. A week later, on September 4, the Australian Securities and Investments Commission filed a multimillion-dollar Federal Court claim against Dixon Advisory & Superannuation Services, a wholly owned subsidiary of Evans Dixon, alleging Dixon Advisory failed to act in its clients’ interests or provide appropriate advice in recommending investments by steering its clients to invest in Alan’s US fund. Later that month, Alan left the US and resumed residence in NSW.

However, the focus here is on what happened in respect of Alan’s four SMSFs. They, of course, paid Australian tax of 15 per cent on their income and Alan personally paid no tax on that income as the money was held inside the SMSFs.

As noted, the US has no equivalent to an SMSF. US tax practitioners believe that such a fund would be a “foreign grantor trust” under the foreign entity classification regulations that would make the members of the fund personally liable to US tax on their share of the fund’s income regardless that the fund is taxed concessionally in Australia.

The double tax treaty between Australia and the US, the orthodox reasoning argued, was no help to Alan because these types of structures are not dealt with by the treaty.

Alan’s US tax advisers had an imaginative different view. They have argued that the funds’ income is exempt under the treaty because the funds constitute foreign social security under Article 18(2) of the treaty and therefore exempt from US tax.

All of this is still before the US courts but the takeaway of this story is that SMSFs whose members and/or trustees are in the US are subject to the lottery of the US foreign entity classification regime. It can classify an SMSF as a structure that itself must pay US tax and whose members resident in the US must also pay tax.

For example the Internal Revenue Service (IRS) in the US might treat an SMSF as a “passive foreign investment corporation”, and subject it to punitive taxation rates.

Attempting to fit the round peg of an SMSF into the square hole demanded by the IRS is best avoided.

The situation needs careful, expert advice and management that may be difficult to find. (Aussie expat Peter has recommended an Ameican law firm which I’d be happy to share upon written request.)

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