It’s easy to underestimate the importance of an SMSF trust deed due to the lengthy, legal and technical nature in which it is written.
As a result, it can often be overlooked by SMSF advisers and auditors.
But the super reforms have reinforced, yet again, that the trust deed is one of the most important documents in the life cycle of an SMSF.
It defines the governing rules of an SMSF, sets out how a fund should be structured and operated as well as outlining the trustee’s duties and responsibilities.
A compliant trust deed is one of the keys to ensuring that the SMSF meets the requirements of the Superannuation Industry (Supervision) Act 1993 and the Superannuation Industry (Supervision) Regulations 1994 (“SIS”), and is eligible for tax concessions and Superannuation Guarantee contributions
And it quickly becomes a critical document in those circumstances where there is a dispute between the trustees, or it becomes the subject of a claim between beneficiaries.
The SMSF Auditor’s Role
As part of their audit planning process, the SMSF auditor is required to examine the trust deed to obtain a sound understanding of the trustee structure, requirements of the deed and the powers vested in the trustees.
One of the most important clauses to verify in the trust deed is whether the fund has been established to meet the requirements of section 62 of SIS – the sole purpose of providing for the retirement of members or their beneficiaries. This clause is usually located at the beginning of the trust deed.
Other sections or regulations of SIS that require the trust deed to be checked at a minimum include:
- S17A – definition of an SMSF
- S67, s67A, s67B – borrowing and limited recourse borrowing arrangements by the fund (the deed of the bare trust should also be checked)
- Sub Reg 1.06(9A) – pension payments made annually and line with the minimum required payment
- Reg 6.17 – payments were cashed, rolled over or allotted in line with SIS
At all times an SMSF auditor must exercise professional judgement and due care in interpreting the provisions of the trust deed, but the advice of an experienced SMSF lawyer should be sought where uncertainty exists.
Payment of Death Benefits
SMSF advisers must ensure that the trust deed is compliant and kept up to date. As case law history shows, the trust deed has been used to overrule the actions of trustees and members, especially when they are no longer around to voice their intentions.
The payment of death benefits, for example, is ultimately a matter for the discretion of the trustee of the fund unless legislation or the governing rules provide otherwise.
Munro v Munro  QSC 61 concerned a dispute between the SMSF trustees and a deceased member’s executors regarding a binding death benefit nomination (“BDBN”) established by the deceased member. The trustees refused to give effect to the nomination as they believed it was invalid.
The BDBN referred to the “Trustee of Deceased Estate” as opposed to the “legal personal representative”. The court ruled that the BDBN was not binding and the death benefits could be paid out by trustee discretion.
The applicants in this case, who were the deceased member’s children from a previous marriage, did not receive any payment.
Incorrectly Executed Trust Deeds
In the circumstances where the trust deed has been executed incorrectly, the deed is not valid, and it fails to be a deed. This provides a catch-22 situation because there are no governing rules in place that allows the trustees to operate the fund and, moreover, the trustees are not considered to be trustees until the deed has been executed correctly.
A common problem is where the trust deed is signed and dated before the corporate trustee is incorporated. As companies are unable to sign documents before they exist, the deed will not be properly executed under these circumstances.
The primary risk associated with defective execution of deeds is that the document may be deemed invalid or unenforceable. This opens an SMSF to a wide range of potential risks, including challenges from beneficiaries and taxation consequences putting the adviser, auditor and SMSF trustees at significant risk.
Where the trust deed has not been executed correctly, the auditor is required to qualify the audit report on s19 but does not have to lodge an auditor contravention report (ACR) with the ATO as this is not a reportable breach.
The increased litigation in the SMSF industry of late, particularly in the context of death benefits, should serve as a reminder of the consequences that can occur should a document be deemed to be invalid or unenforceable.
There are also times when the trust deed may not provide the necessary permission for the relevant transaction, such as when the deed is out of date.
A common occurrence is where an old trust deed does not permit borrowing, and the trustees enter into a limited recourse loan borrowing arrangement (LRBA). There is nothing in 67A SIS that requires the governing rules to authorise the fund to borrow to enter into such a transaction.
In real terms, the trustees have not breached SIS, but there is a breach of trust. The trustees have promised to administer and operate the fund in line with the governing rules. The issue is the conflict between the governing rules and SIS, not SIS itself. There is nowhere in SIS that specifies that a breach of the trust deed is a contravention of SIS.
The auditor should communicate any significant deficiencies or issues relating to the trust deed in the management letter. To ignore the matter altogether may be considered a failure of the auditor to comply with the auditing standards.
It’s safe to say that not all SMSF auditors love reviewing SMSF trust deeds.
But the alternative of ignoring the trust deed can have dire consequences, even when the fund is a simple one.
The life cycle of an SMSF can be complicated. A trust deed will need to be reviewed, and potentially updated, when the fund:
- borrows – funds whose trust deeds pre-date 2007 are not likely to have the ability to borrow for an LRBA arrangement
- pays a benefit – it is important to ensure that the fund can pay out benefits in the manner chosen by the trustee, such as an in-specie transfer
- commences a pension – members must be able to elect the type of pension that they want such as a transition to retirement income strategy
- undertakes estate and succession planning – there needs to be clear rules as to how a BDBN is to be effected and the impact of the death of a member of the fund
Difficulties can arise when the fund wants to undertake an activity the trust deed does not allow or when a trustee wants to rely on what is believed to be the current fund rules.
SMSF advisers should be aware that considerable time, effort and money will be required to try and remedy the problem, usually when it is too late.