In this guide
SMSF trustees bear many responsibilities and sometimes make mistakes when operating and managing their fund. This is one reason SMSFs need to be audited annually by an independent auditor: so they can pick up any inadvertent breaches you may have made.
If your auditor notifies your SMSF of a breach, there’s no need to panic. You may be able to rectify the issue fairly easily. However, if you receive an ATO notification of a breach by your SMSF, it’s important you know what to do and to act promptly.
Although it can be confronting to receive a breach notice, the ATO is generally 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
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, they 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.
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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 you will be able to work with the regulator to fix the problem.
For the 2022–23 financial year, auditor contravention reports (ACRs) were lodged for 15,200 SMSFs, reporting 41,200 contraventions. Those numbers represented 2.7% of the total number of lodging SMSFs and 46% of all those contraventions were reported as rectified.
The most reported contraventions in 2022–23 continued to be loans or financial assistance to members (19%), while in-house assets and separation of assets constituted 16% and 13% respectively.
You can also use the ATO’s early engagement and voluntary disclosure service. The ATO says if you use this service and voluntarily disclose unrectified contraventions before they start an audit, this will be taken into account in determining what action 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 types of contraventions reported to the ATO by SMSF auditors since the start of contravention reporting in 2004 (up to 30 June 2024).
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Distribution (%) of SMSF contraventions by type to 30 June 2024
| Contravention types | As a proportion of the value of contraventions | As a proportion of the value of contraventions |
|---|---|---|
| Acquisition of assets from related parties | 1.0% | 1.8% |
| Administrative-type contraventions | 12.9% | 13.3% |
| Borrowings | 7.3% | 7.6% |
| In-house assets | 16.0% | 24.9% |
| Investments at arm’s length | 7.5% | 10.1% |
| Loan to member/financial assistance | 19.0% | 11.9% |
| Operating standard type contraventions | 9.2% | 7.1% |
| Other | 4.1% | 1.0% |
| Separation of assets | 12.6% | 20.1% |
| Sole purpose | 10.4% | 2.2% |
| 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. Sometimes, SMSF contraventions could result in the fund being taxed at 45% instead of the concessional superannuation rate of 15%. But even in these cases, the ATO may issue enforceable undertakings for the trustee to rectify the issue within six months.
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 superannuation 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.
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Take the example of an SMSF being used as a source of cash 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 up the fund 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 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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