Getting on the front foot and engaging early with the ATO if your SMSF has breached superannuation law

On 15 October 2020, the ATO issued Practice Statement PS LA 2020/3 (Practice Statement) which outlines:

This update focuses on salient points raised by the Practice Statement.

The Practice Statement is a ‘mixed bag’ with some good aspects and some less kinder aspects. On the plus side the Practice Statement acknowledges the harshness of the administrative penalty regime where multiple penalties can apply to what practically is one breach and expressly provides for remissions where the result is unintended or unjust. The Practice Statement’s outline of factors which the ATO sees as relevant for penalty remission is also welcome since the statutory provisions on penalty remission in section 298-20 of Schedule 1 to the Taxation Administration Act 1953 (TAA) are silent on the matter. On the other hand the issue of the Practice Statement signals an intent by the ATO to take a much firmer stance on penalty remissions than it has in the past where it was felt that too many penalties were being remitted for behavior which should have been punished.

What the Practice Statement mostly reinforces is the imperative need for SMSF trustees who discover a superannuation breach to seek specialist superannuation advice promptly and if necessary to access the ATO’s early engagement and voluntary disclosure service as soon as possible. Penalty remission will be a much harder process if the breach is picked up by the ATO.

How the ATO considers the administrative penalty regime operates

Where SMSF trustees breach superannuation law the ATO can apply any one or more of the following compliance actions:

The first three compliance actions listed above only apply to superannuation law breaches which occur on or from 1 July 2014. Prior to this time, the ATO found it difficult to properly discipline SMSF trustees on superannuation breaches since the available compliance actions were not easy to take since civil or criminal penalties required court orders and making a SMSF non-complying was such an adverse action that it was rarely pursued. The enactment of the administrative penalties regime, education directions and rectification directions were aimed at providing the ATO with more flexible disciplinary powers.

Under the administrative penalties regime, where a SMSF trustee breaches a superannuation provision listed in section 166 of the SIS Act, section 166 automatically imposes an administrative penalty.  The following table lists the administrative penalty provisions and the amount of such penalty:

A penalty unit is CPI indexed every three years and is currently $222.

The way that the ATO conceives of a superannuation contravention in the Practice Statement is technical and can lead to multiple breaches (and hence multiple administrative penalties) where practically one might say that only one real breach has occurred. To the ATO’s mind there is no such thing as a continuing contravention which carries over successive financial years. Rather a contravention occurs at a particular point in time and if the breach remains unrectified at the end of the financial year, then a second contravention may be triggered.^[1]

For instance, a SMSF may contravene the rule against lending to members under section 65(1)(a) of the SIS Act when it makes say a $10,000 loan to a member. If that loan is not repaid by the end of the financial year in line with the loan’s repayment schedule, then a second contravention occurs since the SMSF’s failure to seek repayment of the loan in accordance with the repayment schedule contravenes the rule against providing members with financial assistance in section 65(1)(b) of the SIS Act.  That is, by failing to enforce the loan terms financial assistance has been provided. More breaches of this financial assistance rule will occur in each subsequent year where the SMSF trustee fails to repay the loan in accordance with its repayment schedule.

This technical approach to a contravention can result in significant administrative penalty amounts being imposed.  For instance, if no repayments are made on the $10,000 loan to the member for three years this could lead to a prima facie $53,280 administrative penalty (i.e. $222 x 60 penalty units x 4). That is, five times the amount of the $10,000 loan! The approach taken in the Practice Statement is essentially to start from a high base of multiple penalties, and then focus on penalty remission.

The ATO’s stance on contraventions means loan breaches which have occurred prior to 1 July 2014 may still be dragged into the administrative penalty regime.  For example, if a SMSF makes a loan to a member on 1 June 2014, the act of making of the loan is not subject to the administrative penalty regime. However, the SMSF’s failure to require repayment of the loan in accordance with the loan repayment schedule at the end of each subsequent financial year would constitute a breach on which an administrative penalty can be imposed.

The ATO’s position on contraventions reflects the statutory structure of the compliance test for a SMSF in section 42A of the SIS Act. Section 42A generally requires that a SMSF not contravene a regulatory provision on an income year by income year basis in order to continue to be a complying superannuation fund. Where a SMSF breaches a regulatory provision it only continues to be a complying superannuation fund at the discretion of the ATO.

Administrative penalties can be imposed on an individual SMSF trustee or a corporate SMSF trustee. Significantly, where a SMSF has multiple individual trustees then it exposes the SMSF to multiple penalties for the one superannuation law breach. For example, where a SMSF has four individual trustees then a single breach of an administrative penalty may trigger four lots of the administrative penalty – one penalty for each individual trustee.  Continuing on with our $10,000 loan example, the total prima facie administrative penalty amount that can be imposed where the SMSF had four individual trustees is an eye watering $213,120 (i.e. 4 x $53,280).

Only one administrative penalty is imposed on a corporate trustee of a SMSF, however, its directors are jointly and severally liable to pay the penalty.^[2] The fact that a corporate trustee is only subject to one administrative penalty for a breach whilst multiple penalties can apply where a SMSF has multiple individual trustees, is a significant reason besides ease of succession planning for a SMSF to have a corporate trustee rather than the individual members being trustees.

Significantly a trustee cannot seek reimbursement from the SMSF for payment of an administrative penalty.^[3]

How the ATO approaches penalty remission

The ATO has the power to remit the whole or part of an administrative penalty. A remission decision needs to be made for each trustee on whom the penalty is imposed, taking into account the trustee’s particular circumstances.

The fact that a trustee may not have been actively involved in a breach does not automatically lead to penalty remission. Example 9 of the Practice Statement describes a SMSF where the husband is the sole member but the trustees are the husband and wife. The husband makes all the decisions for the SMSF and various superannuation law breaches occur. The ATO did not consider that a further remission of administrative penalty was warranted for the wife. This was because ‘passivity’ is not an excuse since trustees are equally responsible to ensure appropriate controls are in place to prevent contraventions and each trustee needs to ensure they are fully informed about the actions of the other trustee.

The Practice Statement indicates that the ATO considers the following factors to be relevant in considering penalty remission:

The penalty remission factors outlined in the Practice Statement are not exhaustive. The ATO describes its discretion to remit a penalty under section 298-20 of Schedule to the TAA in the Practice Statement as ‘unfettered’. This is to mean that the ATO may remit the penalty in whole or part in any manner it wishes. However, this does not mean that the ATO can do anything it wants. Case law from tax cases indicates that the discretion should be exercised in light of the purpose behind the penalty provisions.^[4] Additionally the tax case law indicates that the relevant question is whether it is appropriate in an individual’s circumstances to remit.^[5] It is not necessary to show special circumstances for remission and remission may be appropriate where the outcome would be harsh in an individual’s particular circumstances.^[6]

A penalty remission decision must be provided in writing with and explanation. A SMSF trustee who is dissatisfied with a penalty remission decision may object and dispute it under Part IVC of the TAA.^[7]

What should a SMSF trustee do now if there is a concern that there has been a superannuation law breach?

If you are a SMSF trustee or a director of a SMSF corporate and are concerned that your SMSF may have breached superannuation law, you should seek specialist superannuation law advice now.

Depending on the circumstances it may be that the specialist advice may confirm that there is no breach of superannuation law at all. If there is a breach then strategies can be considered on how best to minimise penalties and regularise the situation. Such strategies may include implementing a rectification plan prior to, or in conjunction with making a prompt voluntary disclosure to the ATO.  Such a voluntary disclosure should comprehensively outline all relevant facts surrounding the breach including any rectification plan, and also the grounds for penalty remission. The key is rectifying and disclosing prior to the ATO initiating any compliance action.

The ATO has temporarily paused its superannuation compliance activities during this COVID time in light of the financial issues facing SMSF members. Instead the ATO encourages SMSF trustees to engage with them through its early engagement and voluntary disclosure service where breaches have occurred. Affected SMSF trustees should take advantage of this current ATO approach since the Practice Statement clearly indicates that penalty remission is a harder prospect in audit.

It is important to note that a key requirement of using the ATO’s early engagement and voluntary disclosure service that the SMSF be up to date in the lodgment of its annual returns. Accordingly, voluntary disclosure is usually a joint coordinated arrangement alongside the SMSF’s accountant.

Separately, SMSF members should seriously consider whether they should have a corporate trustee for their SMSF to minimise the administrative penalties which may be levied where a breach has occurred. Whilst using a company involves annual ASIC fees (such fees can be reduced if the company’s sole purpose is to act as a SMSF trustee).

Please do not hesitate to get in touch with a member of Coleman Greig’s Taxation and Superannuation Team who have experience in assisting SMSF trustees to navigate superannuation law and making voluntary disclosures on superannuation law breaches with successful results.