By Domenic Festa (Accredited Tax Specialist and Chartered Tax Adviser)
Self-managed superannuation funds (SMSFs), like all regulated superannuation funds, are eligible for significant taxation concessions – most classes of income are taxed at 15%, discount capital gains at 10%, and 0% to the extent the fund is paying pensions to members.
To be eligible for these concessions, the superannuation fund must comply with a number of conditions, to qualify as a complying superannuation fund.
The focus of this article is on certain consequences that can arise from a contravention of one or more of those conditions.
The ATO took over administration of SMSFs in 1999. Initially, the focus of the ATO was on education – educating trustees on how the rules apply with the aim of guiding their behaviour. Over the last 5 to 10 years, the ATO has publicly stated they have moved from education to compliance/enforcement.
In the application of the conditions, there is often a difference in opinion between advisers as to where the yellow line is drawn. The difficulty for the ATO has been that it’s only options for those it considers in breach are quite drastic and unwarranted for minor breaches. The options it has had available are:
- Make a determination that the SMSF is noncomplying. This has the result that the balance in the SMSF (excluding undeducted contributions) is subject to tax at the top marginal rate (45%) and the income of the fund in the year it is classified as noncomplying and subsequent years until it again satisfies the conditions is also taxed at the top marginal rate;
- Obtaining a civil penalty order. This requires an application to court;
- Accepting an enforceable undertaking in relation to a contravention. This requires the agreement of the contravening party;
- Disqualifying the trustee of the SMSF.
Example: David is the sole member of his SMSF. On 1 July 2011 his member balance is $1 million comprised exclusively of deductible contributions and investment earnings. David’s company, David Carpentry Pty Ltd, is in need of $50,000 to finance equipment required for its business. David is aware the superannuation conditions that prohibit the lending of money to a member or relative. The advice he receives is that this condition does not apply where the loan is made to a company controlled by a member or relative. Rather, a loan to such a company falls within the limitation against in-house assets, which allows in-house assets provided they do not exceed 5% of the assets of the fund calculated on a market value basis. Based on the member balance at 1 July 2011, David calculates that he is able to make a loan of $50,000 to his company. On 1 October 2011, David’s SMSF makes a loan to David Carpentry Pty Ltd in the amount of $50,000. The majority of the assets of the SMSF are invested in managed funds. During the quarter ended 31 March 2012 the managed funds suffer a downturn in value by $100,000. The downturn in value is maintained from that time until after 30 June 2013. As a result of the fall in value, the loan to David Carpentry Pty Ltd has exceeded the in-house asset threshold by $5,000. Where an SMSF acquires an in-house asset (in this case by making the loan) that at the time of the acquisition is within the threshold, but subsequently the in-house asset exceeds the threshold due to other events (in this case the downturn in the value of the managed funds), the SMSF is required by Section 82 of the SIS Act to prepare a written plan to rectify the breach by the end of the next year of income (that is, by 30 June 2013). In this case, the SMSF does not prepare a written plan or rectify the breach.
In the example above, the main option for the ATO is to make the fund noncomplying. This will have the effect of imposing a tax liability of $405,000 (45% of $900,000) for exceeding the in-house assets threshold by $5,000 (clearly an inappropriate result).
In these kinds situations, the ATO would like a number of appropriate tools to obtain the right result. For example:
- An appropriate penalty for minor breaches;
- Requiring trustees to do a course to understand the various investment rules applying to superannuation funds;
- Forcing trustees to take action to rectify a contravention of the rules (for example, require a repayment of the loan).
On 18 March 2014, the Tax and Superannuation Laws Amendment (2014 Measures No 1) Act 2014 received Royal Assent. This legislation introduces a number of tools the ATO can use to address contraventions, namely:
- Power to give a direction to rectify a contravention (rectification direction);
- power to give a direction for the trustee to undertake a course of study (education direction);
- Impose a penalty under a graduated penalty regime.
The graduated penalty regime sets out various penalties for certain contraventions. For example:
|Failure to keep financial statements||20 penalty units||$3,400|
|Borrowing not permitted||60 penalty units||$10,200|
|In-house asset rules||60 penalty units||$10,200|
|Failure to keep trustee minutes for 10 years||10 penalty units||$1,700|
|Failure to complete survey form||Five penalty units||$850|
The ATO may remit (reduce) a penalty in accordance with the Taxation Administration Act 1953 where the circumstances justify it.
- SMSFs must satisfy a number of conditions in order to qualify for the taxation concessions that apply.
- Previously, a minor breach of the rules exposed the SMSF to a drastic penalty if the ATO imposed non-complying status on the fund;
- The new rules allow the ATO to impose a penalty appropriate to the breach. In future, it is unlikely that funds will be made noncomplying for other than the most serious breaches.
- We note that a penalty regime of this kind was first announced in the 1999 budget, but never implemented.