There are very serious consequences for breaching superannuation law and regulations, both for trustees and the self-managed super fund (SMSF). While SMSF trustees have the advantage of managing their own retirement savings, they also have the very serious task of ensuring that the fund, its investments and all its undertakings are done in accordance with super law.
The most common SMSF contraventions as at 30 June 2011, according to the Australian Taxation Office (ATO), are:
1. Loans or Financial Assistance to Members (almost 21% of breaches)
Section 65 in the SIS Act prohibits SMSF trustees from lending money or giving any other financial assistance using the fund to its members or their relatives. SMSFR 2008/1 confirms that financial assistance is considered to include any arrangement where SMSF assets are converted into other assets, diverted, diminished, put at risk, or if there is any prejudice to the SMSF’s financial position.
In order to avoid breaching this section, trustees must be vigilant when dealing with members and their relatives. Often, the need to access cash quickly makes borrowing SMSF money a common temptation. To prevent this from happening, it is important to separate bank accounts of the SMSF and individual or business accounts to avoid inadvertently using funds of the SMSF for personal use.
Further, all transactions with members and relatives must be conducted at an arms-length basis. This means that if assets are sold to members or relatives for less than the market value, or bought from them for greater than the market value, it will be caught in section 65. Other situations to watch out for are releasing members or relatives from their obligations to the SMSF, or taking on their financial obligations. Using the SMSF to provide security or give a guarantee for the member or relative’s benefit will also contravene this section.
2. In-house Assets (almost 18% of breaches)
Section 71 describes an in-house asset as a loan to, or an investment in a related party of your SMSF, an investment in a related trust of your SMSF, or a lease of an SMSF asset to a related party. Trustees are restricted from investing in in-house assets up to a maximum of 5% of the SMSF’s total assets. Some exceptions include Business Real Property leased to a related party, investments in widely-held trusts, tenants-in-common property ownership, and certain investments in related non-geared entities.
Trustees need to be aware of the definition of related party, which is broad and encompasses members and standard employer-sponsors of the SMSF and all Part 8 associates. It is important to know both the SMSF’s total asset value and the investment value on the day the in-house asset is acquired because the SMSF is prohibited from acquiring the in-house asset if the fund’s in-house assets already exceed 5%, or the acquisition would cause the level to exceed 5%.
Trustees are required to prepare a written plan to dispose of any in-house assets which breach the 5% level. It cannot be diluted by simply acquiring non in-house assets.
3. Failing to lodge income tax returns on time
SMSFs must lodge a return with the ATO every year after being audited. At 30 June 2011, lodgement performance for 2009 was at 93.5%. The 2010 lodgement rate at 5 July was 79.39%. Trustees should be aware that different lodgement dates may apply to SMSFs depending on whether the return is lodged by self-preparers or tax agents, the SMSF is newly registered, or the SMSF has outstanding returns.
Penalties
Breaching section 65 or 71 may result in either civil penalties or criminal charges against the trustees. The court may order the trustee to pay compensation to the fund, and may order the trustee to pay to the Commonwealth a monetary penalty not exceeding $220,000.
Where the contravention is made knowingly, intentionally or recklessly, with the intention to gain dishonestly or deceive or defraud, criminal penalties may be imposed. These offences are punishable by imprisonment for up to five years. In addition, the SMSF may become non-complying.
The ATO can apply administrative penalties on trustees who lodge SMSF tax returns late, and an interest charge on outstanding debt. SMSF trustees who continue not to lodge returns may receive assessments with penalties. Trustees who do not meet their fund’s lodgement obligations may be prosecuted. The SMSF may also be made non-complying in serious cases.
Consequences of Non-Complying SMSFs
Non-complying SMSFs pay 46.5% tax on their income and the market value of its assets (less non-concessional contributions) in the year prior to becoming non-complying. Additionally, amongst other concessions, they are not eligible for CGT discounts or pension tax exemptions, and a general interest charge may be payable.
However when a contravention has occurred the ATO will not necessarily issue a notice of non-complying status or seek civil or criminal penalties through the courts. Instead, after careful consideration of all the circumstances of the case, Section 42A(5) of the SIS Act empowers the Regulator to give a notice to that SMSF that the entity is a complying superannuation fund in relation to the year of income concerned.
They may accept an undertaking from the trustee to rectify the contravention and undertake education, disqualify trustees, freeze SMSF assets or impose administrative penalties against trustees. However the overriding factor is that discretion will only be exercised where an attempt has been made to rectify the breach and ensure compliance in the future.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should, before acting, consider the appropriateness of the information in regards to their objectives, financial situation and needs and, if necessary, seek professional advice.
