Running an SMSF

Running a self-managed superannuation fund is similar to playing a sport – you need to know all the rules. If SMSF trustees do not understand the rules of the game of superannuation, they are putting themselves and their superannuation at risk.

It is these rules that dictate what their duties and responsibilities are and, when they are not broken, confirm their eligibility for the tax concessions available to complying super funds.

There is another similarity between playing a sport and being the trustee of an SMSF. Breaching the rules brings different levels of penalty, depending on the seriousness of the breach.

In superannuation there are two sets of rules that a trustee of an SMSF must adhere to. There are the taxation rules and the superannuation rules detailed in the SIS legislation.

The attitude of the Australian Tax Office changes and the severity of the penalty increases depending on how serious the breach of the regulations are.

The factors taken into account by the ATO when imposing higher penalties on trustees of an SMSF include whether they have:

• failed to make a reasonable effort to discharge their duties
• repeatedly breached regulations
• knowingly accessed SMSF money prior to retirement
• deliberately set out to avoid their obligations
• refused to take recommended corrective action.

In the first two instances, the ATO starts the process with its equivalent of a yellow card. This can be in the form of requiring trustees to accept a written undertaking that sets out the required actions for the trustees to deal with the breach. In some cases, depending on the severity of the breach, fines or other penalties can also be imposed.

Where trustees' actions are deliberate and more serious, such as the last two instances listed above, they can receive a red card from the ATO. This is understandable, if trustees get to this position they are effectively guilty of spitting in the eye of the ATO.

The heavier penalties imposed by the ATO include:

• disqualifying a trustee or trustees
• removing a trustee
• freezing a fund's assets
• the imposition of substantial fines
• declaring the fund to be non-complying
• prosecuting the trustees for breaking the law and jailing them for up to five years.

Trustees of SMSFs should not be complacent and think that the ATO will never impose the harsher penalties at its disposal. Recent results from compliance activities have shown more funds than ever are being made non-complying. When this occurs 47 per cent of the accumulated assets of the fund, and the ongoing income of the fund, are taken in penalty taxes.

An example of the disastrous effect of a fund being made non-complying is the Kelly super fund that purchased a residential property from its members. The trustees, Ned and Kate, then rented the property to their daughter for a market rent. The fund had a total value of $1,000,000, including the value of the property, and income of $20,000.

Purchasing residential property from members and related parties is banned, as is renting residential property to family and related parties. The ATO required Ned and Kate to sell the property to fix the breach but they ignored the requests and their fund was made non-complying.

As a result the fund received a tax bill for $479,400, made up of 47 per cent of the value of the fund and 47 per cent of the income. Ned and Kate were forced to sell the property to pay the tax bill.

The penalties regime

A major overhaul of the penalties regime applying to SMSFs applying to contraventions and breaches by trustees came into effect from July 1, 2014. The penalties system gives the Commissioner the power to:

• impose administrative penalties without reference to a court,
• require trustees to take specific action to correct breaches, and
• require trustees to undertake education activities.

Under the penalties regime fines will be imposed on either the individual trustees or the directors of the trustee company rather than the fund itself. In addition the legislation specifies that penalties imposed on individuals or directors cannot be reimbursed by the SMSF.

Administrative penalties will not be imposed for all breaches of the superannuation regulations, but will only apply to 17 breaches specified by the new legislation. The fines are applied on a penalty unit basis that range from five penalty units up to 60 penalty units. Each penalty unit has a value of $180 meaning fines will range from $900 up to $10,800.

There are only three breaches where the higher fine will be imposed. They relate to the ban on super funds lending to members, the restriction on a fund borrowing money other than exempted under the SIS Act, such as the limited recourse borrowing arrangements, and for breaches of the in-house asset rules. The smaller fines are imposed for more administrative breaches such as failing to sign required documentation.

If past history is any guide the fines will only be imposed when trustees of an SMSF do not comply either with a rectification direction or an education direction given by the Commissioner.

Rectification directions will specify actions that must be taken by the trustees of an SMSF to fix a breach of the regulations. A time limit will be placed on when the rectification must be completed by and trustees will be required to provide evidence of the actions having been taken.

Where trustees demonstrate that they do not have a proper understanding of the superannuation and SMSF regulations they will be directed to undertake a course of education within a specified time frame.

After the completion of the education trustees will need to confirm that they understand their obligations and duties by signing or re-signing the SMSF trustee declaration form. SMSF's will be banned from reimbursing trustees for the cost of undertaking education courses.

How to avoid penalties

To ensure that their super fund is not put at risk of being penalised trustees should:

• make sure they understand their responsibilities when first becoming trustees by reading the information booklets issued by the ATO, and of course becoming a member of this site
• ask their fund's accountant or auditor for help and guidance when they are unsure of something
• either put in place systems and financial records that provide an up-to-date picture of what the fund is doing on a regular basis, or have the accountant process their fund's financial information before the end of June to detect any problems before the financial year ends
• cooperate at all times with the fund's accountant and the auditor and be guided by what they say
• immediately attempt to fix any problems identified by the fund's auditor or the ATO by taking the action recommended.

No matter how tough the financial situation gets for a member of an SMSF, unless they have met a condition of release, trustees should never be tempted to use the super fund's assets to help a member. The cost of losing 47 per cent of the fund and 47 per cent on the amount paid out incorrectly is just too great.