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Auditor Contravention Reports

Auditor Contravention Reports


by Philip Broderick, DLA Phillips Fox

Released August 2010

ABOUT THIS PROGRAM

This program looks at the responsibilities of auditors of self managed super funds to report contraventions of superannuation legislation to the Australian Taxation Office. It covers:

  • the requirement to report contraventions

  • How the ATO defines ‘contravention’

  • ATO guidance on the contraventions that must be reported

  • The tests for deciding whether to report a contravention

  • Expert commentary on the role of the auditors’ independent professional judgement in light of ATO guidance.

The program includes practical tips on the types of contraventions that auditors must report, and inquiries they should make.

1.  Introduction

Each year a trustee of a self managed superannuation fund (SMSF) must appoint an auditor to give the trustee a report in the approved form.1  As part of the preparation of the report, the auditor must report a contravention of a provision of the Superannuation Industry (Supervision) Act (SISA) or Superannuation Industry (Supervision) Regulations 1994 (SISR).2  That report must be in the form of the Australian Taxation Office's (ATO) document called the auditor/actuary contravention report (ACR).

Traditionally the auditors of SMSFs have been able to exercise their professional judgement when deciding whether to notify the regulator of a contravention.  Since the introduction of the amendments to SISA inserted by the Superannuation Safety Amendment Act 2004, the scope of that professional judgement has been reduced.  Even with those amendments, there was some uncertainty as to whether all contraventions should be reported and whether there is any discretion for minor contraventions.

In 2009 the ATO released the current ACR as an approved form and the accompanying instructions 'Completing the Auditor/actuary contravention report' (ACR instructions).  In the ACR and the ACR instructions, the ATO sets out a set of a seven tests and an 'event' based reporting system that specifies when an auditor must report a contravention and when the auditor can exercise their professional judgement as to whether to report a contravention.

This paper will examine the ACR by, first looking at the background to the legislative provisions, secondly by examining the legislative provisions relating to the ACR, thirdly by reviewing the ACR and the ACR instructions and finally considering whether there is any room left for the auditor's professional independent judgement.

2.  Background to the legislation relating to auditors

The current requirements relating to compulsory contravention reporting by auditors of SMSFs were introduced by the Superannuation Safety Amendment Act 2004 for audit reports prepared from 1 July 2004.

The explanatory memorandum to that Act specified that the Act's benefits include:

'Reforms requiring auditors and actuaries to report to the Regulator at the same time they report certain matters to the trustee will apply to auditors and actuaries of self managed superannuation funds as well as to auditors and actuaries of APRA-regulated superannuation entities.  This will mean that both APRA and the ATO will receive additional information on these matters, enabling them to take necessary pre-emptive action...

The reforms are designed to give [the regulator] the tools it needs to effectively implement the prudential framework.  Ultimately, the new framework should decrease the chance of loss through fund failure, diminishing the call on the Government to provide financial assistance in the event of a failure, and helping to ensure that the superannuation tax concessions provided by Government achieve their objective of greater superannuation savings in retirement.

The Government would also benefit from an increase in community confidence in the superannuation system, ensuring that private savings for retirement continue to play their role as part of the Government’s strategy to address the long-term consequences of an ageing population.'3

It is clear from the explanatory memorandum that the Government's purposes for the requirement of auditors to report contraventions included providing further information to the regulators, allowing the regulators to take 'pre-emptive action' and improving the quality of SMSF trustees.

The ATO also sees the audit of SMSFs as an important regulatory function and consequently has focused on the quality SMSF auditors. This was recently confirmed by the Commissioner of Taxation when he said:

'We have had a focus on auditors for some time now, recognising their importance to the health of the system...

We expect that all approved auditors are up to date and compliant with their professional code of conduct and satisfying their legal, professional and ethical obligations as independent reviewers of SMSFs.

This means an approved auditor should:

  • ensure they are independent and competent before accepting an SMSF audit engagement

  • satisfy all legal requirements to report, both to the trustees and the ATO, on appropriate SMSF contraventions and other events, and

  • adhere to the codes of conduct and other mandated requirements of their professional body which reflect a professional who is fit and proper for that role...

Although we recognise that most auditors are doing the right thing, since July 2008 we have needed to disqualify nine people from the profession. We have also referred 48 auditors to their professional association for disciplinary consideration. These people made clear breaches of their mandatory requirements, including the profession’s code of conduct.

The clear message to take here is that if you are unfamiliar or unwilling to comply with your obligations, then you should improve your skills and attitude or not be an auditor. If you are thinking about bending the rules, ask yourself; 'Is this worth damaging my career?''4

3.  The legislative requirements for the auditing of a SMSF

The legislative requirements for auditing a SMSF and preparing an ACR can be broken down to the following requirements:

Appointment of an auditor

Each year a trustee of a SMSF must appoint an approved auditor to give the trustee a report in the approved form.5

Penalties for the failure of a trustee to comply with this requirement include the draconian and disproportional penalty of up to two years imprisonment6 and the strict liability penalty of a fine of up to $5,500.7

Who is an approved auditor?

An approved auditor includes (among others):8

  • a registered company auditor;

  • a member of CPA Australia Ltd (CPA), The Institute of Chartered Accountants in Australia (ICAA) or the National Institute of Accountants (NIA).

An auditor must not be subject to a disqualification order in force under section 131 SISA or be disqualified under section 130D SISA.

If the auditor is a member of CPA, ICAA or NIA, the auditor must meet the competency requirements (including the professional standards and minimum professional development standards) jointly released by those bodies.9

What is a report in an approved form?

An approved form is defined to mean a form approved by the regulator10 (ie the ATO for SMSFs).  Additional requirements for the approved audit form are set out in section 35C(5) SISA.

Both the auditor's report and the ACR are approved forms for SISA.11

What must the auditor provide to the SMSF trustee and the ATO?

An auditor is required to:

  • each year, prepare an auditor's report in the approved form and provide that report to the SMSF trustee;12

  • where the auditor forms the opinion that it is likely that a contravention of SISA or SISR may have occurred, may be occurring, or may occur, in relation to a SMSF, 'immediately tell the SMSF trustee and the ATO of the contravention in the approved form (ie in the ACR);13

  • where the auditor forms the opinion that the financial position of the SMSF may be, or may be about to become, unsatisfactory, 'immediately' inform the SMSF trustee and the ATO in writing.14

An auditor may provide the ATO with other information not strictly required by the above provisions if the auditor considers that it will assist the ATO in performing its functions under SISA or SISR.15

For a contravention or unsatisfactory position, SISA does not give the auditor any discretion or ability to exercise independent professional judgement where the auditor comes to that belief.  This, if strictly followed, would require all contraventions no matter how small or trivial to be reported. 

However, as noted below, there are some situations where the ACR is not required to be prepared where there have been some 'minor' contraventions.

In practice, the auditor will often have some discretion and exercise some professional judgement in the determining whether there has been a contravention of SISA or SISR. This will especially be so for some of the more "subjective" provisions such as the sole purpose test. Additionally a determination that a trustee "may" contravene a provision will also most likely involve some professional judgement.

The requirements to inform the SMSF trustee and the ATO of contraventions and the unsatisfactory financial position of the SMSF must both be made 'immediately' after the auditor forms the opinion. There is no guidance to what this requires, although immediate suggests straight away. The ACR instructions provide that an ACR must be lodged if in the 'normal course of conducting the audit, you form the opinion that a contravention of the SISA or the SISR has occurred..."16

In practice, the auditor will normally initially form a preliminary opinion. The auditor will then inform the SMSF trustee of that preliminary opinion and request comments and/or an explanation. Once the response has been received the auditor can then form a final opinion and lodge the ACR soon after.

The penalties to the auditor for failure to report a contravention or unsatisfactory financial position include, what are suggested to be similarly draconian and disproportional penalties of up to 12 months imprisonment17, a fine of up to $5,50018 and the strict liability penalty of a fine of up to $2,750.19

There are also penalties for giving false or misleading statements.20

What is a contravention?

Contravention is not defined in SISA for the purpose of section 129 in Division 2 of Part 16 SISA (obligation of an auditor to report contraventions).

Contravention is defined for the purpose of Division 2 of Part 5 of SISA to only include a contravention where that contravention is an offence under SISA or where that contravention can result in a civil penalty provision under SISA.  Under this definition contraventions that do not have those consequences could be ignored. However as that Division relates to making a superannuation fund non-complying, it is likely that 'contraventions' for the purpose of that Division has been deliberately restricted.

Therefore 'contravention' for other parts of SISA, including section 129 SISA, should take its normal meaning.  For example the Macquarie Dictionary defines 'contravene' as 'to violate, infringe, or transgress'.

In the ACR instructions, the ATO defines contravention as an21:

  • action prohibited under the SISA and SISR; or

  • inaction that results in the trustee not meeting their obligations under the SISA and SISR.

For some provisions it will be reasonably simple to determine whether there has been a contravention of a SISA provision. For example whether the trustee or director of a corporate trustee has signed the required trustee declaration.22 While other provisions will require a more 'subjective' analysis as to whether a contravention has occurred. For example the sole purpose test and the requirement to maintain assets on an arm's length basis.

4.  ACRs

Contraventions must be reported if required by the ACR

As noted above, under SISA, an ACR must be prepared by the auditor where the auditor forms the opinion that it is likely that a contravention of SISA or SISR may have occurred, may be occurring, or may occur, in relation to a SMSF.

This strict requirement to notify the ATO in all such circumstances is 'watered down' in the following documents released by the ATO:

  • Instructions and form for approved auditors of SMSFs - which at page 3 provides that an ACR must be prepared where 'you form the opinion that a contravention of [SISA or SISR] specified in the contravention report may have occurred, may be occurring or may occur and the contravention meets the prescribed reporting criteria' (emphasis added); and

  • the ACR instructions -which at page 1 provides 'You must report contraventions and other matters resulting from an event.  An event is an action or inaction by the trustees that may lead, or has led, to one or more contraventions.'

Therefore a contravention is only required to be reported if required under the ACR and ACR instructions (ie that result from an 'event').

Under the ACR only contraventions of the following provisions of SISA and SISR must be reported:23

Section or regulation

Section or regulation title

Does a statutory time period apply?

Section 17A

SMSF definition

 

Section 35C(2)

Trustee to provide documents to the auditor

Yes.  Trustee/s must ensure that requested relevant documents are given to the auditor within 14 days of the request being made.

Section 52(2)(d)

Separation of assets

 

Section 62

Sole purpose test

 

Section 65

Lending or providing financial assistance to members or their relatives

 

Section 66

Acquisition of assets from related parties

 

Section 67

Borrowing by the fund

Yes.  For borrowing exceptions only.  A temporary borrowing to pay beneficiaries or to make a super surcharge payment must not exceed 90 days.

A temporary borrowing to cover settlement of securities transactions must not exceed seven days.

Section 82

In-house assets – exceeding in-house assets ratio

Yes.  Market value ratio for the 2000–01 year of income and later years of income.  If it exceeds 5%, the trustee must prepare and carry out a written plan to reduce the market value ratio to 5% or less before the end of the next following year of income.

Section 83

In-house assets – prohibition on further acquisition

 

Section 84

In-house assets – reasonable steps

 

Section 85

In-house assets – avoidance schemes

 

Section 103

Minutes and records

 

Section 104A

Trustee declaration

Yes.  A trustee declaration in the approved form must be signed within 21 days of becoming a trustee (or a director of a corporate trustee) of an SMSF.

Section 109

Investments to be maintained on-an-arm’s length basis

 

Section 126K

Disqualified persons not to be trustees

Yes.  Trustee must immediately tell us in writing if a trustee is or becomes a disqualified person.

Regulation 4.09

Investment strategy

 

Regulation 5.08

Minimum benefits

 

Regulation 6.17

Restriction on payment of benefits

 

Regulation 7.04

Acceptance of contributions

Yes.  Returning contributions to members, for example, where no TFN is quoted.

Regulation 13.14

Charges over assets of the fund

 

Contraventions of provisions not listed above are not required to be notified to the ATO in the ACR.24 The auditor can exercise their professional judgement as to whether such non-listed contraventions should be reported to the ATO.

The provisions listed above comprise most of the relevant provisions applicable to SMSF trustees in SISA and SISR and therefore there will generally be few instances where an auditor will have to consider a non-listed contravention.

Reporting contraventions under an ACR

According to the ACR instructions, an auditor must report contraventions and other matters resulting from an 'event'.

An event is 'an action or inaction by the trustees that may lead, or has led, to one or more contraventions.'25  In order to determine what contraventions must be reported, an auditor must work through the seven tests set out in the ACR.

For each contravention, the auditor must separately work through the seven tests.

These tests are explored in further detail below.

Test 1: Fund definition test

Test 1 asks 'Did the fund fail to meet the definition of an SMSF?'

If the SMSF fails this test then this contravention must be reported. 

A SMSF will meet the definition of a SMSF where it satisfies the definition under section 17A SISA.  For example an auditor must be satisfied that the SMSF has no more than four members and each member is a trustee or director of a corporate trustee (unless an exemption applies).

Test 2: New fund test

Test 2 asks 'As at the end of the financial year is the SMSF less than 15 months old?'

If the SMSF is less than 15 months old at the end of a financial year then all contraventions must be reported.  That is the financial thresholds (see tests 6 and 7), which would otherwise act so as not to require a contravention to be reported, will not apply to new SMSFs.

Trustees of newly established SMSFs should exercise extra diligence to ensure they do not contravene the provisions of SISA and SISR set out in table 1 of the ACR instructions, as even minor contraventions must be reported.

This requirement is consistent with the ATO's focus on compliance by newly formed SMSFs.26

Test 3: Trustee behaviour test - repeat contraventions

Test 3 asks 'Has the trustee/s previously received advice of a contravention that they breached again?'

If the trustee of a SMSF contravenes a provision of SISA or SISR that they have previously been advised that they had breached, then the auditor must report this contravention in the ACR.  The financial thresholds (see tests 6 and 7) will not apply to repeat contraventions.

This test does not specify whether the prior contravention was recent and therefore presumably applies to contraventions in all prior years.  The test also does not specify that the auditor must proactively seek information relating to prior contraventions.

To the extent that the auditor has not audited the SMSF in the past, it would be prudent for an auditor to ask the trustee if it has been previously notified of any SISA or SISR contraventions and seek prior auditor reports for the SMSF.

Test 4: Trustee behaviour test - unrectified contraventions

Test 4 asks 'Is there an identified contravention from a previous year that has not been rectified at the time the audit is being conducted?'

If, by the time the audit is being conducted, the trustee of a SMSF has failed to rectify a previous contravention, then the auditor must report this contravention in the ACR.  The financial thresholds (see tests 6 and 7) will also not apply to unrectified contraventions.

It is therefore important that where an ACR is not required to be prepared for a contravention that the contravention is rectified by the time the SMSF is next audited. Otherwise an ACR must be prepared.

Test 5: Trustee behaviour test - failure to meet a statutory time period

Test 5 asks 'Did the trustee/s fail to meet a statutory time period by more than 14 days?'

This is another strict test that must be reported if there is a contravention.  Again, the financial thresholds (see tests 6 and 7) will not apply to time period contraventions. 

This test gives an additional 14 day period after the statutory due date.  For example the trustee of a SMSF must provide an auditor with information within 14 days of a request being made.  The auditor will not be required to report the failure to provide the information if it is provided in period from 14 to 28 days after the request (unless test 3 applies - ie the trustee has contravened this provision before).

Test 6: Financial threshold test - less than 5% of the SMSF's assets

Test 6 asks 'Was the total value of all contraventions greater than 5% of the total value of the fund's assets?'

This is the first financial threshold under which an auditor is not required to report a contravention (unless one of the prior tests applies). 

For in-house asset breaches the 5% threshold is in addition to the 5% in-house asset limit.  For example the trustee of a SMSF could hold in-house assets up to 10% of the Fund's asset values (provided tests 3 and 4 do not apply and the financial threshold in test 7 is not breached).

It is not clear from the ACR instructions whether contraventions with no monetary value will be given a nil value for the two financial threshold tests or whether all such contraventions must be reported.  For example, the failure of the trustee of a SMSF to prepare minutes and keep records under section 103 SISA.

The view that is consistent with the nature of the financial thresholds (that is to allow one off minor contraventions to go unreported) would be to give such contraventions a nil value and therefore such contraventions would not be reported unless there was a repeat contravention (test 3) or an unrectified contravention (test 4).

Test 7: Financial threshold test - contraventions greater than $30,000

Test 7 asks 'Was the total value of all contraventions greater than $30,000?'

This is the second financial threshold under which an auditor is not required to report a contravention (unless one of the prior tests applies).  Provided that all of the other tests are not breached, contraventions with a value of no more than $30,000 do not need to be reported.

Passing all seven tests - no report required

If the answer to all seven questions is no, then the contravention does not need to be reported. 

However the auditor still has the discretion to report a contravention in accordance with the auditor's professional judgement and the auditing and assurance standards.

How are the financial thresholds calculated?

The ACR instructions do not specify how to calculate the value of the SMSF's assets and the value of the contravention.  However it is the ATO's policy that the value of assets of a SMSF must be reported at market value.27 The ATO will presumably administer the financial thresholds in the ACR in a similar manner.

For the value of a leasehold interest under the in-house asset rules, the ATO takes the view28 that value will be the value of the asset not the value of the lease.29  In the ACR instructions (see example 7) the ATO gives the example of the use by a member of a residential property for three weeks where the member pays a commercial rent.  According to the ATO the value of the contravention is not the commercial rent paid by the member but rather the value of the property ($400,000 in the example).

Where there are multiple contraventions, the value of each contravention will be added together for the purposes of the financial thresholds.  For example the following is an extract of example 7 from the ACR instructions:

Was the total value of all contraventions greater than 5% of the total value of the fund’s assets?

Yes.  Use of rental unit causes it to become an in-house asset contravening section 83 in-house assets – prohibition on further acquisition.

  • The market value of the rental unit is $400,000.

  • The in-house ratio is calculated at 95.23% (400,000 ÷ 420,000[being the total value of the fund]) which is over the statutory 5% limit.

  • The allowable in-house assets amount is $21,000 (5% × $420,000).

  • The maximum value of the contravention is $379,000 ($400,000 – $21,000)

The total value of all contraventions is calculated as follows:

* Section 65 – lending or providing financial assistance to members.

* Section 109 – investments to be maintained at an arm’s length basis

* Section 83 – in-house assets – prohibition on further acquisition

* Section 84 – in-house assets – reasonable steps

* Total value of all contraventions

$5,453

$453

$379,000

$379,000

$763,906

As the total value of all contraventions is greater than 5% of the total value of the fund’s assets ($763,906 ÷ $420,000 = 181.8%) all identified contraventions must be reported.  Sian does not need to apply test 7.

You will notice in the above example that the ATO counts a breach of the in-house asset rules twice.  First as a breach of section 83 SISA (by acquiring in-house assets in excess of 5% of the market value of the SMSF's assets) and secondly as a breach of section 84 SISA (being the requirement to take reasonable steps to comply with the in-house asset rules).  If this view was correct then all in-house asset contraventions would be calculated multiple times.

In the author's view this cannot be correct.  The only contravention in this situation is under section 84 SISA.  That is because it is only a contravention of section 84 SISA that will cause the trustee to be liable to a penalty.  Failure to comply with the in-house asset rules, including section 83, are simply the preliminary tests to determining whether section 84 SISA has been contravened.  That is, there is only one contravention of the in-house asset rules, not two.

5.  Is there any room left for an auditor's independent professional judgement?

Effectively an auditor cannot exercise the auditor's professional judgement where the auditor comes to the opinion that the trustee of the SMSF has contravened any of the provisions of SISA and SISR listed in table 1 of the ACR instructions.

An auditor will still be able to exercise the auditor's independent professional judgement30 for a contravention of a provision not listed in table 1 of the ACR instructions and for any other matter that the auditor considers will assist the ATO in performing its functions under SISA or SISR.31

Additionally an auditor will have to exercise professional independent judgement to determine whether a provision of SISA or SISR has been contravened and whether there "may be" a contravention.

FOOTNOTES

  1. Section 35C of the Superannuation Industry (Supervision) Act 1993

  2. Section 129 SISA

  3. Paragraphs 3.47, 3.61 and 3.62 of the explanatory memorandum to Superannuation Safety Amendment Bill 2003

  4. Speech by Michael D’Ascenzo, Commissioner of Taxation, to the Self-Managed Super Fund Professionals’ Association of Australia (SPAA) National Conference, Melbourne, 17 February 2010 titled 'A common caring: nest building with self-managed super funds'

  5. Section 35C SISA

  6. Section 35C(3) SISA

  7. Section 35C SISA

  8. See section 10(1) SISA and regulation 1.04 of the SISR

  9. See the Competency Requirements for Auditors of Self-Managed Superannuation Funds released by the representatives of the Australian accounting profession (CPA, ICAA and NIA)

  10. Sections 10(1), 11A, 35C and 129 SISA

  11. See page 1 of the ACR instructions

  12. Section 135C SISA

  13. Section 129 SISA

  14. Section 130 SISA

  15. Section 130A SISA

  16. Page 1 of the ACR instructions

  17. Sections 129(3C) and 130(3C) SISA

  18. Sections 129(5) and 130 SISA

  19. Sections 129(6) and 130(5) SISA

  20. See sections 129 (3B) and 130(2B) SISA

  21. See page 4 of ACR instructions

  22. As required under section 104A SISA

  23. See table 1 of the ACR instructions

  24. One example of a non-listed provision is the duty of a trustee of a superannuation fund to notify the regulator if it becomes aware of the occurrence of an event having a significant adverse effect on the financial position of the superannuation fund under s106 SISA.

  25. Page 1 of the ACR instructions

  26. For example see Speech by Michael D’Ascenzo, Commissioner of Taxation, to the Self-Managed Super Fund Professionals’ Association of Australia (SPAA) National Conference, Melbourne, 17 February 2010 titled 'A common caring: nest building with self-managed super funds'

  27. For example see Self Managed Superannuation Funds Determination SMSFD 2008/2 and the ATO's fact sheet titled 'The economic downturn and self-managed super funds'

  28. Relying on the Explanatory Memorandum to the Superannuation Legislation Amendment Bill (No.  4) 1999 at Item 26

  29. See Self Managed Superannuation Funds Ruling SMSFR 2009/4 at paragraph 126 and the ACR instructions

  30. See ASAE 3100 on how an auditor may exercise the auditor's professional judgement

  31. Section 130A SISA

STUDY POINTS

  1. What are the penalties imposed on the auditor for failure to report a contravention of superannuation legislation to the ATO?

  2. How does the ATO define ‘contravention’? Name three contraventions that the ATO says must be reported.

  3. List the seven tests for deciding whether to report a contravention to the ATO.

  4. An auditor discovers that a self managed fund has committed a contravention valued at $35,000. Should the auditor report this?

  5. If a self managed super fund passes the financial threshold tests, but the trustee has committed a repeat contravention, must the auditor report it to the ATO?

  6. Is there any scope for auditors to exercise discretion in deciding to report contraventions by self managed super funds of superannuation legislation?