When SMSFs go off the rails: play ball with the ATO or pay the cost

​On 18 September 2015 the Federal Court ordered that two trustees of a self managed superannuation fund (SMSF) pay the Commonwealth monetary penalties of $20,000 each.

We may see fewer cases like this in the future, as the powers of the Commissioner of Taxation (Commissioner) to issue administrative penalties under s 166 of the Superannuation Industry (Supervision) Act 1993 (SIS Act) now enable him to impose punishment for a range of breaches without resort to the civil penalty regime. Nonetheless, the Commissioner retains the power to initiate civil penalty proceedings against trustees, and may still choose to do so in the most serious cases, and where breaches do not attract an administrative penalty. Most notably, breach of the sole purpose test falls within this category.

Deputy Commissioner of Taxation (Superannuation) v Ryan [2015] FCA 1037

In this case the Federal Court considered the appropriate penalty for contraventions in relation to a series of loans or advances that were made to members of an SMSF over a period of four years.

Facts

The relevant background was as follows:

• Mr and Mrs Ryan, a married couple, started an SMSF together.
• They purchased a dry cleaning business, funded partly with a line of credit.
• The business was not successful and it was sold in 2007. The proceeds of the sale did not clear the advances made to them under the line of credit.
• By 12 June 2009, they were unable to meet their personal expenses, including in relation to the line of credit, and started making withdrawals from the SMSF to pay expenses.
• Between 12 June 2009 and June 2012 they withdrew a series of amounts (about 68 loans and payments) from the SMSF totalling $209,677. Over this period some of the loans were repaid, however none of the loans were secured or on appropriate repayment terms, or had interest charged.
• Between August and December 2012, the SMSF’s accountant and auditor lodged the returns and reports for the previous four financial years, which raised the possibility of contraventions of the SIS Act.
• On 16 October 2013, the Commissioner wrote to Mr and Mrs Ryan asking each of them to show cause as to why they should not be disqualified.
• On 19 November 2013, Mr and Mrs Ryan replied to the Commissioner acknowledging the contraventions and apologising for their actions, and offering to rectify the contraventions and to roll-over their superannuation benefits and wind up the SMSF. They were subsequently disqualified, but no other penalties were imposed.
• Presumably the contraventions were not rectified and the SMSF was not closed and, as at 1 June 2015, Mr and Mrs Ryan held superannuation benefits in the SMSF of $6,034.20.
• On 22 May 2015, the Deputy Commissioner informed Mr and Mrs Ryan that proceedings were to be commenced.
• On 1 June 2015 Mr and Mrs Ryan’s superannuation benefits were rolled over into a public offer superannuation fund and presumably the SMSF was wound up.

Decision

The facts alleged in the statement of claim by the Deputy Commissioner were not disputed by Mr and Mrs Ryan, and a joint agreed statement of facts was agreed and lodged. Therefore Justice Edelman only had to make declarations of the contraventions, and to consider the amount of the civil penalties that were appropriate in the circumstances.

Justice Edelman summarised the judicial authority on the civil penalty provisions in the context of SMSFs, and noted that the cases show the range of civil penalties applied in circumstances where individuals commit a series of related contraventions in an SMSF context is generally between $10,000 and $35,000.  He said that the appropriate approach was to assess the general run of cases and synthesise where the current case falls within that general run.

In setting the penalties, His Honour took into account matters including:

• the seriousness of the contraventions, including the fact that the SMSF’s funds were almost exhausted;
• that the Ryans had previously made unauthorised withdrawals from the SMSF, that had been subject to an enforceable undertaking to rectify;
• that the Ryans were not in a strong financial position; and
• that the Ryans had co-operated with the Commissioner in relation to the proceedings.

The case demonstrates some key lessons for advisers and trustees of SMSFs on how to manage issues once an SMSF has gone off the rails, and how to approach and deal with the ATO.

Lessons learnt

Lessons to be drawn from this case include:

• Don’t let returns go unlodged

  Here the income tax returns and auditor reports were not lodged for the relevant years (2009, 2010, 2011 and 2012) until late 2012.  It may be that the run of breaches would have been brought to an end had the SMSF been audited after the first year of the breaches, and the position would most likely not have led to the Deputy Commissioner taking the action she ultimately did.

• Make a rectification plan and carry it through

  The Commissioner will give trustees of an SMSF who contravene the SIS Act a reasonable opportunity to rectify the contraventions and avoid monetary penalties. In this case, Mr and Mrs Ryan had over 18 months from the time the Commissioner first wrote to them asking them to show cause as to why they should not be disqualified before the Deputy Commissioner commenced proceedings.

  Also, as was evident in this case, the Commissioner will expect that an agreed rectification plan is implemented. By not following through with their agreement to rectify the contraventions and wind up the SMSF, Mr and Mrs Ryan may have effectively left the Deputy Commissioner with no choice but to commence proceedings.

• Get on the front foot

  It is always better to approach the Commissioner with information about a problem within an SMSF and a plan to fix it, than to wait to receive a show cause letter as in the present case. It seems clear from speeches made by representatives of the Australian Taxation Office over recent times that the same principle will apply in relation to the new administrative penalties.

Conclusion

If a contravention does occur, unknowingly or otherwise, it is imperative to act promptly, to be pro-active in rectifying the issue, and to co-operate with the Commissioner. SMSF trustees who simply put their heads in the sand, or who fail to carry through on promises made to the Commissioner, may find themselves on the receiving end of significant penalties. This may be even more important for contraventions that occur after 1 July 2014, as the Commissioner can impose administrative penalties on trustees for contraventions of his own initiative, rather than having to apply to the Federal Court to impose a monetary penalty.