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Everybody makes mistakes, and SMSF trustees are no different. There are many rules and regulations SMSF trustees must adhere to and which auditors must ensure have been complied with when they do their annual audit of an SMSF.
If your auditor notifies your SMSF of a breach, you may be able to rectify it fairly easily. However, if you receive an ATO notification of a breach by your SMSF it’s important you know what to do, and take action quickly.
It can be quite confronting to receive such a notification and it is not unusual for SMSF trustees to wind up their SMSF as a result.
However, the ATO can also be understanding if a trustee indicates they are prepared to fix the problem quickly. So, to help you get back in their good books, we’ve put together the following steps for dealing with any notice you might receive from the ATO.
Step 1: Talk with your auditor
Every super fund needs an annual audit report from an independent auditor when they file their tax return. Auditors are required to report any contraventions they find to both the SMSF trustee and the ATO. Your auditor will be the first external person to know of a contravention and, having possibly dealt with contraventions before, may be able to give you some idea of what the ATO might do and your possible course of action. This could give you some time to prepare.
Step 2: Research
What you need to do will depend on the type of contravention letter you get from the ATO.
Step 3: Work with the ATO
Even if your fund has a contravention reported by your auditor to the ATO, it is highly likely will be able to work with the regulator to rectify the problem.
For the 2020–21 financial year, auditor contravention reports (ACRs) were lodged for 13,900 SMSFs, reporting 40,200 contraventions. But 45% of all those contraventions were reported as rectified.
According to the ATO’s disqualified SMSF Trustees Register, just 197 trustees were disqualified that same year, out of the nearly 14,000 SMSFs that had contraventions.
You can also use the ATO’s early engagement and voluntary disclosure service. The ATO says that if you use this service, and voluntarily disclose unrectified contraventions before they start an audit, this will be taken into account in determining what other actions the ATO will take.
Trustees are expected to have a plan in place for rectifying the breach when they use the ATO’s early engagement service.
The table below shows the most common types of contraventions to watch out for, with loans to members, in-house assets and separation of assets the main offenders.
Distribution (%) of SMSF contraventions by type to 30 June 2021
| Contravention types | As proportion total contraventions | As proportion of value of contraventions |
|---|---|---|
| Acquisition of assets from related parties | 1.1% | 2.0% |
| Administrative type contraventions | 11.7% | 8.0% |
| Borrowings | 7.7% | 8.2% |
| In-house assets | 17.3% | 27.1% |
| Investments at arm’s length | 7.4% | 9.4% |
| Loan to member/financial assistance | 20.0% | 13.6% |
| Operating standard type contraventions | 8.2% | 6.0% |
| Other | 4.1% | 0.9% |
| Separation of assets | 12.7% | 21.9% |
| Sole purpose | 9.9% | 3.0% |
| Total | 100% | 100% |
Source: ATO
Step 4: Weigh up your options
Educational directions and rectification directions are not as harsh as some of the other avenues available to the ATO. They instruct SMSF trustees to either fix a problem or educate themselves on the responsibilities of being a trustee around a problem.
Graeme Colley, Super Concepts executive manager, SMSF Technical & Private Wealth, recalls one case in which an SMSF trustee was unaware that their SMSF contravention could result in the fund being taxed at 45% instead of the concessional superannuation rate of 15%. That trustee had contravened the in-house asset rules by investing in a family unit trust by much more than the statutory 5% permitted under the in-house asset rules. The ATO issued an enforceable undertaking for the trustee to rectify the issue within six months.
“This occurred as it frightened the client that the fund could be taxed as a non-complying fund,” Colley says.
More severe transgressions are likely to receive non-compliance notices, trustee disqualifications and civil and criminal penalties. These are known as ‘removal’ enforcement actions. They are intended to remove wayward trustees and their SMSFs from the concessionally taxed environment.
Step 5: Comply with the directive and/or wind up your fund
If the ATO issues a ‘removal’ enforcement action it expects the SMSF will be wound up. A trustee disqualification means a trustee is no longer able to operate an SMSF and a wind-up is the only course of action. For non-compliance cases the cost involved in making the fund compliant may be too much for the fund and it could choose to wind up instead.
Take the example of an SMSF being used as a cash supply for an individual who had not yet reached their preservation age. If the fund’s balance was relatively low, the trustee could decide to wind the fund up instead of rectifying the breach of both the sole purpose test and the preservation standards.
The bottom line
The good news is that most trustees work with the ATO to rectify contraventions before they even get to the stage of issuing a directive. As long as you don’t behave in a manner that shows a blatant disregard for the law, or intentionally seek to misuse your SMSF to take advantage of lower tax rates, chances are you won’t get a blemish on your SMSF trustee record.
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