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The trustee–member rules explained: Part 2

By William Fettes ([email protected]), Senior Associate, DBA Lawyers

The trustee–member rules set out in s 17A of the Superannuation Industry (Supervision) Act 1993 (Cth)(‘SISA’) must be satisfied on an ongoing basis by each self managed superannuation fund (‘SMSF’). Indeed, it is critical that advisers and SMSF trustees are mindful of these rules to ensure the relevant fund maintains complying status and accordingly continues to receive concessional tax treatment.

In Part 1 of our series, we considered a number of exceptions and conditions to the application of the rules. In this Part 2 ‘sequel’, we explore some useful tips and traps.

(All legislative references are to the SISA.)

Tips and traps #1 — grace period

An important aspect of the trustee–member rules is the six month grace period that applies in certain scenarios where the basic conditions are not satisfied.

Specifically, s 17A (4) provides that a fund does not automatically cease to be an SMSF where the usual relevant trustee–member criteria is not satisfied. Under s 17A(4), a period of six months can elapse during which time the fund will continue to meet the definition of an SMSF, despite the fact that the usual trustee–member criteria is not satisfied.

Given that six months can pass quickly, prompt action is required to ensure that a fund falls within the grace period where any departure from the trustee–member rules have occurred. Examples of this could include:

  • appointing a minor member (eg, who was previously under a legal disability because of their age)as a director of a corporate trustee within six months of their attaining age 18; or
  • admitting new fund members within six months of a change of trustee occurring where the new trustees have not yet been admitted as fund members.

However, the six month grace period is not available in all circumstances, and in light of this, we now consider a key exception to the grace period.

Tips and traps #2 — timing in the context of member admission

The admission of a new member to an SMSF is an exception to the six month grace period under in s 17A(4).

Specifically, s 17A(5) provides that the six month grace period does not apply in respect of a failure of the basic conditions caused by one or more new members being admitted to an SMSF. On a practical level, this means that a prospective new fund member mustalways be appointed as a trustee/director before their admission as an SMSF member.

Indeed, as the grace period will not provide a safety net in these circumstances, the timing and order that any change of trustee/director composition changes are carried out is thereby critical in the context of member admission. Notably, failure to satisfy the rules in s 17A when admitting new fund members will result in a fund instantly ceasing to meet the definition of an SMSF.

Tips and traps #3 — failing to meet the definition under s 17A

So what happens when a fund ceases to meet the definition of an SMSF (eg, due to member admission missteps)?

The ramifications of failing to meet the definition of an SMSF can be serious and should not be underestimated, even where the fund’s auditor has not positively identified the breach. The ATO provide the following commentary on the relevant repercussions in SMSFR 2010/2 [66]–[68]:

The fund ceases to satisfy the definition of an SMSF

  1. If a fund ceases to satisfy the definition of an SMSF in section 17A, the Commissioner of Taxation will retain powers of administration as regulator of the fund until a registrable superannuation entity (RSE) licensee is appointed as trustee. The trustee must notify the Commissioner within 21 days of the fund ceasing to be an SMSF.
  2. Funds that no longer meet the definition of an SMSF need to:
  • restructure the fund to again meet the SMSF conditions;
  • appoint an RSE licensee as trustee and become regulated under APRA; or
  • wind up the fund.
  1. If the trustees of the fund do not rectify the situation, the fund’s complying status may be removed. A non-complying fund is taxed at the highest marginal tax rate (currently 45%) on its income and the market value of assets just before the start of the year in which it is made non-complying rather than only on the income of the fund at the concessional rate of 15%.

Broadly, if a fund fails to meet the definition of an SMSF, it is generally recommended that remedial action is taken as soon as possible to bring the fund back into alignment with the trustee–member composition rules.If this cannot be achieved, the member should consider other options, such as rolling over all of their benefits to a large fund (ie, winding up the former SMSF) or converting the SMSF to a small APRA fund (‘SAF’).

If prompt action is not taken, the fund exposes itself to the risk of having its complying status removed by the ATO. Where a fund loses its complying status, it will be taxed at the highest marginal tax rate on its income and the market value of its assets, prior to the start of the year that it was made non-complying.

When you compare this tax outcome to the 15% rate that generally applies to a complying superannuation funds compared to 15% on the low tax component, the importance of satisfying the SMSF definition immediately becomes crystal clear.

Tips and traps #4 — Disqualified persons

Broadly, only persons who are not disqualified are permitted to be fund trustees/directors under s 120. Refer to the following article for further information in relation to disqualified persons in an SMSF context:

Indeed, it is an offence for a disqualified person to continue to act as a trustee/director under s 126K. Therefore any disqualified person must be removed as a trustee/director as soon as possible. Moreover, the trustee–member rules expressly preclude a disqualified person from using a legal personal representative(eg, an attorney under an enduring power of attorney) to act in their place at as a trustee/director.Accordingly,a disqualified person cannot have their attorney act in their stead to overcome the trustee–member rules; they must therefore cease their membership in an SMSF within six months of becoming disqualified. Naturally, the removal of a disqualified person in an SMSF with two individual trustees will likely invoke other ramifications and the appointment of a corporate trustee for the remaining member may be the best outcome.

Notably, where a person is disqualified the two main rectification options are to roll over the disqualified person’s benefits to a large (APRA-regulated) superannuation fund (eg, an industry or retail fund) or convert the SMSF into a SAF by appointing an APRA approved trustee.

Note that if the disqualified person has retired or attained age 65 or satisfied another relevant condition of release with a nil cashing restriction, they could alternatively consider withdrawing all of their benefits from the SMSF.

The following scenario explores some of the relevant issues that can arise in the event that an SMSF member becomes a disqualified person:

  • Jim is the sole director/trustee and sole member of the Jimbo Investments Super Fund (‘Fund’). The Fund has a number of assets, including real estate that serves as the premises for Jim’s small business. Jim is caught up in some shady activity and is convicted of an offence involving dishonest conduct and is thereby rendered a disqualified person.
  • As a starting point, Jim will need to consider rolling out all of his benefits in the Fund, and the Fund’s current portfolio of assets will not be maintainable unless Jim is somehow able to coax additional persons (eg, family members) to join his fund and make contributions or roll overs. While Jim may consider transferring his benefits in the Fund to a large (APRA) superannuation fund, he would generally need to realise the assets (ie, sell the real estate) to enable a roll-over to an APRA fund as such funds will not typically accept in specie roll-overs.Unsurprisingly,Jim is devastated by the requirement to dispose of the business premises (as he does not have the cash to purchase it from the Fund) and he has not met a relevant condition of release so transferring the premises that way is not an option.
  • As an alternative, Jim could consider appointing an RSE licensee to convert the fund to a SAF. However, doing so is easier said than done. If Jim was to contemplate converting the Fund to a SAF, he would need to follow the service provider’s specific process in relation to on boarding the Fund, taking into account their rules and requirements. He would likely also need to update the Fund’s trust deed. The difficulty does not stop here, as most companies that offer SAFs have very specific requirements in relation to the fund’s assets and it is likely that the fund’s modest, undiversified portfolio would not be accepted in these circumstances.

Given the complexities that can arise in the context of an SMSF member becoming a disqualified person, SMSF trustees and advisers should obtain expert advice to help them navigate these issues.

Tips and traps #5 — SMSF residency

SMSF residency is another source of common pitfalls in relation to the trustee-member rules.

For a fund to be an Australian superannuation fund and maintain its complying status, a number of requirements must be satisfied in relation to SMSF residency. Unless the central management and control (‘CM&C’) of the fund is ordinarily located in Australia,the fund may lose its complying status.

Accordingly, members departing overseas can present a challenge for maintaining SMSF residency, including in relation to CM&C being located in Australia. Section 17A (3)(b)(ii) provides an option to help manage this CM&C aspect.

Pursuant to s 17A(3)(b)(ii), a member may appoint a locally-based attorney under an enduring power of attorney to act in place of that member at the trustee/director  level(see SMSFR 2010/2) so that the CM&C of the fund is not in doubt while the member is overseas.Note, however, that the member would need to cease as a trustee/director to rely on an exception to the basic conditions.

The ATO have indicated that alternate directors can also be used as a tool to satisfy the CM&C test for SMSF residency purposes (see SMSFR 2010/2 [51]–[55] for further information).

However, as touched on in Part 1 of this series, DBA Lawyers does not recommend the use of alternate directors in an SMSF context, particularly for SMSF residency purposes, as alternate directors can give rise to ambiguity and conjecture about who is empowered to act as a director at any given point in time.Indeed, the use of alternate directors for SMSF residency places the complying status of a fund at risk, as it is generally easy for directors to act that may comprise the CM&C requirements.

The clearest method is for the trustee/director to resign as a director and appoint their locally-based attorney in their place as a full director.


The technical aspects of the trustee–member rules in s 17A of the SISA can trip up well-informed SMSF trustees/directors and advisers. As evidenced by this series, there are many nuances and complexities to the trustee–member rules that must be considered when operating an SMSF, particularly when contemplating changes to the fund’s composition of trustees/directors.

This article provides a general summary only and does not consider all relevant aspects of s 17A and broader superannuation law. Expert advice should be sought, particularly in the event of a member’s death or loss of capacity.

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

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