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SIS Compliance Problems: Dealing with the ATO

SIS Compliance Problems: Dealing with the ATO

by Graeme Colley, One Path

Released January 2012

SIS Compliance Problems: Dealing with the ATO.  

Most of us would like to think our self-managed superannuation fund (SMSF) complies absolutely with the Superannuation Industry (Supervision) Act 1993 (SIS Act) and associated legislation.  However, the truth is that in most cases it is usually not the situation and compliance breaches of a very minor nature may reveal themselves even after the efforts of the most diligent SMSF trustee, accountant and auditor.  In the simplest case the apparent failure to meet the SIS Act and Regulations may arise due to differences in interpretation of the relevant law, accounting or auditing standard.  At the other end of the spectrum, however, breaches of the legislation may be due to recklessness of the trustees or sheer ignorance of the professionals involved.  In other cases the breach may be due to fraud caused by the criminal activities of unscrupulous operators who promote illegal access to fund assets or member’s benefits.

The Scheme of the SIS Act

The scheme of the SIS Act has a number of components in the process of being treated as a regulated fund and complying with the legislation which is illustrated in Attachment A.  As a general rule the regulator is not able to take action due to the breach of any covenants in section 52, however, the SIS Regulations do permit penalties to be imposed for non-compliance with certain of the covenants, for example, Reg 4.09, which is an operating standard for purposes of Part 3 of the SIS Act.  The remedy for breach of a covenant in section 52 is provided in section 55 which allows a person who suffers loss or damage as the result of the conduct of another person engaged in the contravention of a covenant may recover the amount of the loss or damage by taking action against the other person involved in the contravention.  Refer to the decision in Dunstone v Irving [2000] VSC 488 on the operation of section 55 of the SIS Act.

The SIS Act provides the ATO as regulator of SMSFs with a range of penalties that can be used where breaches have occurred or are likely to occur.  Penalties can include:

  • Issuing a notice of non-compliance to the fund (subsection 40(1))

  • Seeking a court order (subsection 262A)

  • Disqualifying an individual and prohibit them from acting as trustee of a superannuation fund allowing the trustee to correct the relevant breach (section 126A)

  • Suspending or removing a particular trustee (subsection 133(1))

  • Freezing the assets of a fund if there is a risk of the member’s benefits being eroded (section 264)

  • Seeking civil and/or criminal penalties through the courts (part 21).

Part 3 of the SIS Act provides that the SIS Regulations may prescribe standards required to be met by the fund.  Where the standards are not met penalties can be imposed in accordance with section 34. 

Where certain provisions in the SIS Act such as the in-house assets rules, lending to members and relatives or borrowing rules are breached Part 21 authorises a court to impose monetary as well as criminal penalties.  There are other sections where the penalties are included in the particular provisions, for example, section 66 which contains a custodial penalty of up to one year in gaol.

In most cases the threat of imposing penalties or being challenged in court has the desired effect to have the breach corrected or, in those cases where the breach is not able to be corrected, the likelihood of it reoccurring is greatly reduced or even eliminated.  Those cases which have come before the courts and administrative tribunals that relate to breaches of the SIS Act generally display behaviours where the trustee(s) have failed to take the opportunity to correct the situation.  This has usually occurred after being given a reasonable chance by the regulator to rectify the breach.  A summary of some of those cases is included in Attachment B.

The declaration of the fund as a non-complying fund

Being declared non-complying is not as easy as it may seem.  Some trustees and their accountants are wrongly of the opinion that they can at whim decide for themselves that the fund is complying or non-complying if a breach has occurred.  What they have failed to remember is that when the fund became regulated the trustees signed an irrevocable election that the SIS Act applies in relation to the operation of the fund.  It is the regulator who makes the decision to treat the fund as non-complying with its attendant taxation consequences.  

During recent years there has been a large percentage increase in the number of funds which have been treated as non-complying by the ATO.  This has been due to an increase in the audit activity of the ATO and for the 2009/10 financial year is over 100 cases.

Overall, the percentage of the SMSF population with Audit Contravention Reports from the year ended 30 June 2004 to 30 June 2009 audit years has remained relatively stable at approximately 2% of all SMSFs each year.24

There were 8,126 SMSFs that had ACRs lodged containing 17,866 contraventions in the year ended 30 June 2010. Just under half of these contraventions were reported as rectified.

According to the Commissioner contraventions range from administrative contraventions to those considered more serious, such as breaches of the in-house asset rules.  The most commonly reported contraventions were loans or financial assistance to members (20%), while in-house assets and separation of assets constitute 17% and almost 14% respectively. In monetary terms, these two contraventions represent over 25% and 28% respectively of the reported contraventions up to 2010. (ATO: Self-managed superannuation funds: A statistical overview published 12 December 2011)

Being declared non-complying under section 40(1) of the SIS Act has a significant impact on the fund.  The market value of the SMSF at the end of the year of income immediately prior to being made non-complying less any undeducted and non-concessional contributions is included as assessable income of the SMSF.  The tax payable on the taxable income of the SMSF is 45% rather than the ordinary rate of 15%.  If the SMSF is in pension phase the income will not be exempt and taxed at the penalty rate of 45%. This is in addition to any other penalties the ATO may decide to impose on the trustees including disqualification and seeking imposition of civil or criminal penalties under the legislation.

The usual source for a fund to commence its route to be declared non-complying is the lodgement of an Auditor Contravention Report (ACR) which forms part of the SMSF’s annual audit.  Completing the Auditor/actuary contravention report

(NAT 11299) published by the ATO provides a good summary of when and how an ACR needs to be lodged.

If the ATO considers a closer review of the fund is warranted a ‘Notification of audit For your action’ will be sent to the trustee, usually via the fund’s tax agent, asking for further information concerning the relevant contravention that has been reported.  The ATO in most cases allows up to one month to provide the information required.

Depending on the information submitted to the ATO by the trustee the ATO may come to the conclusion that a contravention occurred.  If they decide the fund should be declared non-complying a Statement of Reasons is provided explaining the reasons for their decision.  The trustee will be given the opportunity to provide reasons why the fund should not be made non-complying.  Based on any additional information provided by the trustees the ATO will determine what action it will take.

Once the fund has been treated as non-complying an assessment or amended assessment will be issued by the ATO on the calculation of taxable income as indicated above.  The notice of assessment or amended assessment taxing the fund as non-complying as well as the notice of non-compliance is reviewable.  If the trustees do not agree with the decision of the Commissioner a request for review of the ATO’s decision is generally required as well as an objection against the fund’s income tax assessment.  A review must be made within 21 days of the notice of non-compliance being issued, however, four years is available to lodge an objection against the income tax assessments for the fund.  It is usual that an extension is required for the lodgement of the review in view of the short time allowed by the SIS Act.  The Commissioner will usually allow an extension in most cases.

The Commissioner’s Discretion

It does not necessarily mean that because an Auditor Contravention Notice has issued and a contravention has been identified the ATO will treat the fund as non-complying and issue a notice of non-compliance.  The ATO has a number of options available to it and may decide to seek one or more of the penalties that are available.  The six types of penalties that the ATO may seek are indicated above.

One exception to these rules is where a fund has failed to meet the definition of an Australian superannuation fund in section 295-95(2) of the Income Tax Assessment Act 1997.  The Commissioner has no discretion to overlook the failure of a fund to meet this definition and is bound to issue a notice of non-compliance.  Review at the administrative appeals tribunal level or even in the courts will be a worthless exercise as there are no rights of appeal available.  Refer to the decision in CBNP Superannuation Fund and the Commissioner of Taxation [2009] AATA 709 for commentary on the operation of this provision.

In an attempt to provide policy guidance to ATO staff and the general public the ATO has issued a number of practice statements to assist in understanding how the law is to be administered in a practical sense.  In relation to the exercise of discretion by the Commissioner in relation to the issue of a notice of non-compliance ATO Practice Statement Law Administration 2006/19 (para 34) indicates the factors to be used in making the decision include:

  • The behaviours of the trustee in relation to the contravention.  A contravention resulting from the recklessness or intentional disregard for a regulatory provision is likely to be considered more serious than a contravention resulting from an honest mistake.

  • The extent to which the contravention affects the fund’s assets.  The greater the proportion of the fund’s assets affected by the contravention, the more serious the contravention is likely to be.

  • The extent to which the fund’s assets are exposed to financial risk and whether there is any loss to the value of the fund.  The greater the proportion of the fund’s assets exposed to financial risk and the greater the loss suffered by the fund, the more serious the contravention is likely to be.  However, a contravention may still be serious if a significant proportion of the fund’s assets have been put at risk, even though the fund has not suffered any actual loss.

  • The number and duration of contraventions over a period of time.  A single contravention on its own may not be considered serious, but a number of contraventions taken together may make the situation more serious.  In addition, the longer a contravention continues without any attempt to rectify it, the more serious it is likely to be.

  • The nature of the contravention in the overall scheme over a period of time.  For example, a contravention involving an artificial arrangement intended to undermine a regulatory provision is likely to be considered a serious contravention.

It seems clear from these statements in the Practice Statement that trustees should endeavour as best as possible to rectify any breach as soon as they become or are made aware of it.  If the rectification of the contravention has taken place prior to the lodgement of the Auditor Contravention Notice which will indicate the breach has been corrected.

In some cases it may be difficult, if not impossible to rectify the breach due to the effluxion of time.  An example of a breach that is impossible to rectify is where a pension may have been under or over paid in a year of income.  In these cases all that can be done in practical terms is to make certain the breach will not occur again by putting in place a correct process to ensure the correct amount of pension is paid.

If a contravention is not able to be corrected by the time the Auditor Contravention Notice has been lodged one option open to the trustee is to offer the ATO a written undertaking.  If this undertaking is accepted by the ATO it becomes an Enforceable Undertaking.  If it is breached the ATO can apply to the courts for an order in relation to the breach.  An Enforceable Undertaking may be one way of avoiding the fund being declared non-complying accompanied by the relevant taxation penalties.  Refer to the decision in AAT Case [2011] AATA 563 Re Smith and FCT a summary which is included in Attachment B to this paper.

Whether an Enforceable Undertaking is accepted by the ATO depends on a number of factors.  ATO Practice Statement Law Administration PSLA 2006/18 indicates at paragraph 19 the factors the Commissioner is willing to take into account in accepting an undertaking:

  • Can the contravention be rectified? For example, a contravention of the in-house asset rules can be rectified by the fund disposing of relevant assets.  If a contravention cannot be rectified, then an undertaking is not appropriate.

  • Does the contravention give rise to criminal consequences?  Where there are criminal consequences it is not appropriate to accept an undertaking.  This reflects the principle that a person may not contract out a criminal liability.

  • Past behaviour of the trustee.  It would be appropriate to accept an undertaking where the behaviour indicates that the trustee is likely to comply with it.  However, it may not be appropriate to accept an undertaking if the trustee has contravened the provisions which they had previously completed an undertaking to rectify.

  • The nature and seriousness of the contravention indicates that it is in appropriate to accept an undertaking.  For example, 100% of superannuation contributions, when received, are immediately lent to members.

In accepting an Enforceable Undertaking the ATO will take into account the timeframe offered to rectify the contravention.  If this is long then the ATO is unlikely to accept it.  Refer to the decision in JNQV and Commissioner of Taxation [2009] AATA 522 where two undertakings were offered by the trustees to rectify a breach of the loans to members operating standard.  Both of these undertakings were rejected by the ATO as they were set too far into the future.

The lesson to be learned is that once contraventions of the SIS Act and Regulations are detected they should be rectified as soon as possible.  If it is necessary for the fund auditor to lodge an Auditor Contravention Notice it is preferable for it to confirm the breach has been rectified.  If this is not possible then an undertaking should be offered to the ATO and indicate how it will be rectified within a short and realistic timeframe.

In any case the trustees should keep in mind that if the fund is treated as non-complying that they have all the relevant information available to support their contentions and co-operate with the ATO staff so that the compliance status of the fund is preserved at all cost.



Olesen v MacLeod [2011] FCA 229

A penalty of $12,500 has been imposed for a trustee of an SMSF for the illegal release of benefits in breach of the sole purpose test.

The facts involved the rollover of a payment of $40,032 in August 2005 and the subsequent withdrawal of $20,028 to settle some legal proceedings for a former client.  Further amounts were withdrawn in 2006 and 2007 to meet other financial needs in relation to school fees and due to a relationship breakdown.  These contraventions were reported by the fund auditor in 2007 and despite this other amounts were subsequently withdrawn from the fund.  In January 2010 the fund was closed and any remaining assets were transferred to a retail superannuation fund.  The ATO disqualified the trustee.

The Federal Court held that the trustee had contravened the sole purpose test by the significant number of withdrawals and that financial assistance was provided to the member under section 67 of the SIS Act by using the resources of the fund.  The Court imposed the civil penalty of $12,500 due to the seriousness of the breach over a number of years and the deliberate nature of the breach.

Olesen v Eddy [2011] FCA 13

A penalty of $15,000 was imposed on an SMSF trustee for the unauthorised early release of benefits in breach of the sole purpose test.

The facts in this case were that an SMSF was established in 2005 and $75,570 was withdrawn from the fund over 2005 to 2008.  The auditor of the fund identified the breaches which represented 98% of the fund and referred to as loans to the member.  The Commissioner applied to the Federal Court to impose a civil penalty on the trustee.  The Court held there was a breach of the sole purpose test because of the multiple withdrawals which were not authorised and also the member had obtained financial assistance to a member using the resources of the fund.  In relation to the amount of the penalty took into account the members personal circumstances and other financial pressures surrounding his divorce.  But on the other side of the coin there were 160 deliberate contraventions sustained over a sustained period.

AAT Case [2011] AATA 403 Triway Superannuation Fund

The Commissioner’s decision was confirmed by the AAT that the Triway Superannuation Fund should be treated as a non-complying superannuation fund despite the fact that the son of a couple who were all members had taken money from the fund which had been concealed by the parents for five years.  In its decision the AAT considered that the breaches of the superannuation standards were particularly serious and that for the Commissioner to treat the fund as complying in the circumstances was inconsistent with the provisions of the SIS Act.

AAT Case [2011] AATA 563 Re Smith and FCT

The AAT confirmed the Commissioner’s decision which included income paid from an SMSF in breach of the SIS Act.  The taxpayer and her husband operated a real estate business which was having difficulties and the bank decided to extend credit.  In order to avoid having the business being put into voluntary liquidation the taxpayer accessed money from her SMSF.  The business was able to survive due to the injection of cash from the SMSF and the money was returned to the fund.

The amounts taken from the fund in breach of the SIS Act were included in the taxpayer’s assessable income in the 2007/08 and 2008/09 tax years as the Commissioner declined to exercise his discretion under section 304-10.

The AAT held that the Commissioner was correct not to exercise the discretion as it considered SMSFs were not to be used as a lender of last resort and that the benefit provided to SMSFs was a privilege that should not be abused.

Olesen v Parker [2011] FCA 1096

Penalties of $50,000 were imposed by the Federal Court on the trustees of an SMSF for various breaches of the in-house asset rules in Part 8 of the SIS Act as well as being maintained solely for superannuation purposes.  The breaches were:

  • Making loans to and an investment in related companies which were in-house assets of the fund;

  • Failing to prepare written plans for the disposal of in-house assets as required by Part 8 of the SIS Act;

  • Not requiring interest to be paid on the loans in terms of section 109(1) of the SIS Act;

  • That the fund was not maintained solely for superannuation purposes in terms of section 62(1) of the SIS Act.

The fund was audited twice by the ATO in the 2003/04 and 2005/06 tax year.  During the first audit a number of breaches were identified and some were not rectified.  These, however, were rectified as part of an Enforceable Undertaking executed by the taxpayer and accepted by the ATO.  Further breaches of the in-house asset test were reported to the ATO during the 2005/06 tax year.  Due to the breaches the ATO issued notices of non-compliance and the trustees were disqualified as trustees.

In its decision to impose the penalties, the Federal Court considered that the contraventions of the SIS Act that took place over more than 3 years were deliberate and not as a result of ignorance.  In addition, some of the amounts that had been put at risk with the related party were lost and not able to be recovered.

International Art Holdings Pty Limited (admin app’td) v Adams NSWSC 164

The NSW Supreme Court ruled in International Art Holdings Pty Limited (admin app’td) v Adams that nothing prevents a court from placing an equitable or statutory lien over artwork owned by an SMSF in order to secure the competing claims of an administrator.

The facts of the case involved a group of companies that carried on a business as art dealers.  The SMSF had purchased a number of artworks which were leased to earn income.  The use of the artwork was to be consistent with the provisions of the SIS Act so that they were not to be encumbered in any way.  Various deficiencies arose in the business dealings of the company and a dispute arose as to the number of artworks that could be identified as forming part of the artworks in possession of the company.  The administrator sought to have a statutory lien placed over the artwork owned by the SMSF.  The trustees of the SMSF argued that to have the statutory lien placed over the artwork would be a breach of the SIS Act.

The Court decided that while the SIS legislation did prevent a trustee from giving a charge over or in relation to an asset of the fund the provision only relates to the trustee of a superannuation fund and not to another party.  In relation to a statutory lien there was no basis on which the trustee could be said to have allowed a charge to be placed over the assets of the fund.  The fact that the lease agreement in relation to the artworks prevented a lien being placed on the artworks did not prevent the statutory lien from being placed over the assets.