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Changing SMSF trustees — why advisers should be more alert to the tips and traps

Changing SMSF trustees — why advisers should be more alert to the tips and traps

This article examines some of the key reasons for having a company appointed as an SMSF trustee as compared to having individual trustees. It also examines some issues that can arise when advisers are preparing change of trustee documents.

Why do so many SMSFs have individual trustees?

SMSFs can have either have a company or individuals appointed as trustees. It seems however that the vast majority of SMSFs have actively chosen individual trustees.

According to ATO statistics in mid-2013 around 76% of all SMSFs had individual trustees. Of the 556,998 SMSFs at 30 June 2015, this would result in some 423,318 SMSFs having individual trustees and 133,680 SMSFs having corporate trustees. These statistics are not encouraging given the many advantages of having a corporate trustee for an SMSF.

Query then, why have so many SMSFs chosen individual trustees ― is it simply because individual trustees is considered the ‘cheaper’ option? A corporate trustee should result in a considerable saving of money over the long-term and provides considerable ongoing advantages from a succession planning and asset protection perspective.

There have also been suggestions that some advisers in their eagerness to establish an SMSF for a client do not wish to complicate the client’s decision by raising the option of a corporate trustee.
As a lawyer practising predominantly in this area for many years, I would never recommend individual trustees; I would always strongly recommend a sole purpose corporate trustee.

One day an argument may well be put by SMSF trustees against an adviser who recommended individual trustees when those trustees suffer damages by not having a limited liability company (eg, if a claim is made against the SMSF’s individual trustees for fire damage to the occupants of a property where the insurer denied liability as the premises were only covered by a commercial permit).

While it is possible that some SMSF members may initially be put off by the cost of establishing and running a company, SMSF advisers should explain the pros and cons of establishing a company to act as an SMSF trustee as compared to having individual trustees. In so doing, the adviser should provide impartial, factual and balanced information for a client to make a sound judgement. I would like to think that, after advisers discuss the numerous advantages of having a company act as an SMSF trustee, the overall number of SMSFs with individual trustees would reduce substantially below the current 76% level.

Some of the key advantages of having a corporate trustee include:

  • Continuous succession ― a company has an indefinite life span. A company makes succession to control more certain on death or incapacity.

    For example, in Katz v Grossman [2005] NSWSC 934, an expensive and protracted legal battle in the NSW Supreme Court arose between the deceased’s (Ervin Katz) two children Daniel Katz and his sister Linda Grossman over who controlled the fund.

    Linda, the daughter, was the only remaining individual trustee after the death of her father (who was the sole member of the fund). Linda was appointed as a co-trustee with her father after her mother’s death (Evelin Katz). Following her father’s death, Linda decided to appoint her husband Peter as co-trustee despite her late father’s wish that his death benefit be shared between his two children equally.

    If a company had been appointed as trustee, there would have been no need for Linda to have been appointed as a co-director with her father. Moreover, Mr Katz could have left shares in his trustee company equally between his two children in his will. Mr Katz should also have, in hindsight, left a binding death benefit nomination directing his super benefit to be paid to his two children equally.

  • Administrative efficiency ― on the admission or cessation of membership, that person becomes or ceases to be a director of the company. Thus, the title to all assets remains in the trustee company’s name. The situation is vastly different with individual trustees. Each admission or exit of a member, who is also a trustee, involves considerable time and paperwork. In addition to transferring title to each asset the newly constituted individual trustees, a new bank account needs to be opened. The upfront cost of appointing a company as trustee, saves on the considerable downstream costs when, for instance, someone dies and a new trustee or member is appointed.

    For example, referring back to the case of Katz v Grossman above, Mrs Katz passed away and Linda was appointed as co-trustee with her father. When her father subsequently passed away Peter, Linda’s husband, was appointed as co-trustee. Thus, in this case, there were two changes of trustee being mother to daughter and father to son-in-law. Both of these changes of trustee were undertaken at a time when deceased estates were also being administered adding considerably to the paperwork that needed to be attended to at a very inconvenient and stressful time.

  • Sole member SMSFs ― you can have an SMSF where one individual is both the sole member and the sole director; as opposed to sole member funds with individual trustees where you must have two individual trustees. As discussed above, Mr Katz could have simply become the sole director/member of his own SMSF following the death of Mrs Evelin Katz. Instead, Mr Katz made a strategic mistake when he relied on individual trustees and appointed his daughter Linda as co-trustee. An adviser assisting in this change of trustee could have been subject to a negligence claim if they did not provide the advice that a company has numerous advantages as outlined above (see Carr-Glynn v Frearsons [1999] Ch 326, for instance, for a case where a lawyer that failed to advise on converting an interest in property from joint tenants to tenants in common so that it would form part of the testator’s estate was liable to the beneficiary who missed out on that interest). If after providing such advice, the client decided to stick with individual trustees, then the client should have no cause of action against the adviser.
  • Greater asset protection ― as companies have limited liability, they provide greater protection. One example is provided above in relation to a legal claim against a property owner where the insurer relies on an exclusion clause. I have also come across numerous examples where the limited liability feature of a company has saved the directors from losing all their personal assets including their family home and being rendered bankrupt. The advantages of limited liability should never be under estimated.
  • Administrative penalties ― there are a number of penalties that can readily be imposed under s 166 of the Superannuation Industry (Supervision) Act 1993 (Cth) by the ATO where no questions are asked, ie, strict liability offences where intent or excuses are not relevant (eg, contravening the sole purpose, provision of financial assistance to members and in-house asset rules). Each individual trustee is subject a penalty of up to $10,800 per offence. In comparison, a company is only liable to one penalty amount per offence.

There are further compelling reasons why I strongly recommend corporate trustees and these reasons can be found on the DBA Lawyers’ website. Indeed, I do not have any sound reason for recommending individual trustees.

Advisers should encourage clients to move to corporate trustees

Indeed, I urge advisers to encourage their SMSF clients with individual trustees to move to a corporate trustee as soon as practicable as not having a corporate trustee can result in costly disputes. For example, advisers just have to consider their own client base and realise the number of Katz v Grossman type family disputes that are just waiting to happen. There is no easy or smooth succession available with changing individual trustees. A company with an appropriately worded constitution can, on the other hand, offer smooth succession to control.

Note that companies whose sole purpose is to act as an SMSF trustee are eligible for a special discount to the usual ASIC annual review fee (around 20% of the usual annual fee applies for a sole purpose SMSF trustee company). For the reasons outlined above, I generally consider that having a corporate trustee is the only option that results in overall savings in the long-term. In my view, there is no compelling reason that I am aware of that would lead me to recommending individual trustees ― as noted above, they are not even a cheaper option and in my view are a strategic mistake.

Why you should get an SMSF law firm to prepare your change of trustee documentation?

There are a number of steps involved with changing an SMSF trustee. The key steps include:

  • A careful review of the prior document trail ― preferably each prior deed and deed of change of trustee is carefully reviewed to determine what are the most appropriate provisions that apply to changing the trustee. This review should also ascertain what documents have been validly executed to determine what constitutes the operative deed.
  • A review of applicable legislation such as the Trustee Act and stamp duty legislation of the relevant jurisdiction. In some cases the SMSF deed does not contain adequate power and a resort to the provisions in the Trustee Act of the relevant jurisdiction is required. Indeed, Linda Grossman relied on the provisions of the Trustee Act 1925 (NSW) in appointing her husband Peter as co-trustee in Katz v Grossman. The case of Katz v Grossman provides an interesting examination by the court of the deed and the appointment of Peter as a co-trustee, with reliance on the Trustee Act 1925 (NSW), was held to be valid.
  • In cases where the deed is out of date and does not have clear power to undertake a change of trustee, updating the deed first is advisable to ensure there is clear and appropriate power.
  • I also recommend that the SMSF deed have an appropriate ‘appointor’ power as the ability to appoint and remove trustees is one of the most important powers that can be exercised in relation to controlling an SMSF. This power should ideally be exercised by the members who have the ability to appoint and remove trustees. However, since around 70% of SMSFs have two members, this would mean in practical terms that both members would need to agree to each change of trustee. This could naturally result in a deadlock if both members do not agree. To overcome any such deadlock, the deed can provide that the member or members with the greater account balances have the right to appoint and remove trustees. This power could also assist overcoming a situation where the shares in a corporate trustee are wholly owned by one member with the smaller fund balance as the member with the larger fund balance (who may not be a shareholder in the trustee company) should be in a position to appoint a new trustee since they have the greater fund balance.

Documenting a change of SMSF trustee is a task best left to an SMSF lawyer. While it has become common for non-lawyers to prepare such documents, it is critical that you have a lawyer review the document trail to ensure the change of trustee procedure is strictly followed.

This point needs to be considered more carefully by many advisers who often use simple trustee resolutions to change trustees. These resolutions typically do not cover:

  • The liability of the outgoing and incoming trustee.
  • Whether there is any indemnity for the outgoing or incoming trustee and, if so, from or to when.
  • What happens if the outgoing trustee refuses to transfer assets to the incoming trustee.
  • Other matters that are set out in a deed of change of trustee including what governing law applies (particularly as individual trustees may be in different jurisdictions) and the ability to execute in counterparts as there are occasions where the different parties refuse to sign the same document, eg, divorce.

It is critical to note that if there are any deficiencies in the appointment of trustees, that any subsequent deed amendments are likely to be invalid. For example, if a deed purports to appoint a corporate trustee and remove two individual trustees which is deficient, then that company would not be validly appointed as a trustee. Consequently, subsequent deeds executed by that company would be invalid as the company was not properly appointed in the first place. I have found this to be a common error in many change of trustee documents prepared by advisers who are not lawyers. The other common mistake I find which will render a purported appointment invalid, is where the procedure to appoint and remove a trustee under the deed are not complied with.

The case of Moss Super Pty Ltd v Hayne [2008] VSC 158 (‘Moss Super’) provides a good example of how a party acting in the wrong capacity resulted in the deed of change of trustee being rendered invalid.

Moss Super involved a dispute over the benefits of a deceased SMSF member, Mr Hayne. After Mr Hayne’s death, his partner Ms Moss sought to change the SMSF trustee to Moss Super Pty Ltd (a company of which Ms Moss was the sole director). The appointment power in the SMSF deed required the founder to appoint any new trustee. Ms Moss was a director of the founder company. However, when executing the change of trustee documentation, Ms Moss signed in her capacity as the sole remaining member of the fund only and not in her capacity as director of the founder company. As a result the change of trustee was invalid. Ms Moss’ attempt to take control of the SMSF was therefore blocked. An extract from paragraph 30 from Moss Super sums up the position as:

If parties have, no doubt for good reason, established a complicated legal structure such as this, they must respect it. And where they have, as here, multiple roles to play they must respect the conflicts which may arise.

This risk of this type of situation arising may be avoided if a lawyer had reviews the document trail, identifies the appointment power and ensures the appropriate change of trustee documentation is prepared and executed by each party who is acting in the correct capacity.

As well as ensuring compliance with the governing rules of the fund, it is also vital to have a well-drafted change of trustee deed which provides peace of mind for both the outgoing and incoming trustee. The DBA Lawyers’ change of trustee deed includes a release where each outgoing trustee is indemnified for any act or omission as a trustee after the execution date. The new trustee is also protected from liabilities prior to the change of trustee documents being executed.

Unless a change of trustee is appropriately managed, costly and protracted litigation may arise. Advisers who are not registered lawyers also need to be aware that preparing and advising on a change of trustee is legal work. Thus, if there are any shortcomings, the adviser will be liable without being covered by their professional indemnity insurance. Moreover, advisers undertaking legal work for a fee will be liable to the usual criminal penalties under the applicable legislation that regulates the legal profession in each jurisdiction. Note, for example, s 10(1) of the Legal Profession Uniform Law Application Act 2014 (Vic) provides:

An entity [which includes both companies and individuals] must not engage in legal practice in this jurisdiction, unless it is a qualified entity.
Penalty: 250 penalty units or imprisonment for 2 years, or both.

The case of Legal Practice Board v Computer Accounting And Tax Pty Ltd [2007] WASC 184 is a good example of the risks associated with an adviser who obtained a pro-forma SMSF deed from an online supplier and merely inserted names and details of a client to set up a new SMSF. Broadly, the adviser had contravened the Western Australian legal practice rules but was lucky to get let off any penalty on a technicality.

The process, steps and documents needed to document a change of trustee is invariably far more complex than establish a new SMSF. In addition to the usual superannuation and tax rules, there are special state and territory laws that need to be considered as well as stamp duty rules in the relevant jurisdiction.

Conclusions

Advisers should be pro-active in encouraging their SMSF clients to move to a corporate trustee. There are significant risks involved with not properly documenting a change of trustee. Unfortunately, advisers often overlook the complexities that relate to changing trustees. Legal advice should be obtained when changing an SMSF trustee to ensure compliance with the fund’s deed and to minimise any disputes arising in the future.

This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.

Note: DBA Network hold SMSF CPD training at venues all around Australia and online. For more details or to register, visit www.dbanetwork.com.au or call Marie on 03 9092 9400.

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