26/11/2014

Trustees were reminded earlier this month of the potentially heavy financial consequences of not understanding their responsibilities as trustees or directors of a corporate trustee of an SMSF.

The reminder came as the Federal Court decided earlier this month to accept the parties' agreed penalty amount of $40,000 for various contraventions by the corporate trustee of the Graham Family Superannuation Fund ("the Fund").

The contraventions were several:

-    The Fund purchased a residential property and leased it to the members' son - rent was not paid by the son despite the existence of a lease.
-    The Fund purchased a caravan, cattle, a motor vehicle and used Fund's money to pay for associated costs; no income was generated by those items.
-    Up to 80 outgoings were treated as loans from the Fund to the members.

It was agreed by all the parties that the sole purpose test, prohibition against loans to members, in-house asset rules, and the arms-length rule were breached by the trustee.

The parties further agreed with the amount of the penalties to be imposed, being $30,000 towards the husband and $10,000 towards the wife, in addition to an equal splitting of the ATO's legal costs of $10,000.  The discrepancy in the penalty amounts was because the husband was considered to have been the more dominant trustee in many of the Fund's dealings.  

The Court, who was asked to examine the agreed penalty amounts to ensure they fell within the acceptable range having regards to the circumstances of the case, decided that the penalties were appropriate and did not require adjustment.

How is this case useful?

Section 62A of the Superannuation (Industry) Supervision Act 1993 basically prohibits trustees from maintaining an SMSF for purposes other than for the provision of benefits specified in subsection 62(1).  Maintaining an SMSF for other purposes is in contravention of s62.  The ATO has previously determined that the consideration of all events and circumstances in relation to the maintenance of each SMSF must be undertaken objectively in each case, which means they must be seen through the eyes of a reasonable observer.

The Federal Court has now provided a little more insight on what that test requires when it declared that the sole purpose test was breached in various ways, namely:

1.    by making loans to provide financial accommodation to the members on non-arms-length terms; and
2.    by providing rental accommodation on non-arms-length terms to the son of the members.

While the words 'arms length' are not used in section 62, it appears from the decision that if, in the course of maintaining the SMSF, the trustee acts on an arms-length basis, then a reasonable observer is very likely to conclude that it was done to provide retirement benefits for the members.

This seems to indicate that the question of whether the fund has been making investments at arms-length is a weighty factor to be taken into account when determining whether a contravention of the sole purpose test has occurred.

New Penalty Regime

It is worth noting that the decision of the Federal Court was made in the context of the old penalty regime which required the ATO to apply to the Court in order to have the penalties enforced.

In light of the new penalty regime, it is likely that the ATO will use its new powers and apply administrative penalties rather than going to court.

While the new penalty regime is still in a transition phase, the main changes between the two approaches would be:

-    fines to be imposed on each individual trustees;
-    a penalty could be levied for each contravention as opposed to the 'single course of conduct' approach taken by the ATO in the Graham case; and
-    the concept of a 'dominant' and 'passive' trustee to become obsolete as the ATO will no longer consider the extent of each trustee's involvement.  This means that there will be no adjustment of the penalty based on the respective involvement.

As noted in the Graham case and recent comments by the ATO, co-operation with the ATO and prompt rectification of contraventions will be positively looked upon by the regulator.  

For more information regarding this article, please call Julie Hartley at Townsends Business & Corporate Lawyers on (02) 8296 6222.