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Self Managed Super Fund (SMSF) Article
How super funds are made non-complying

By Tony Negline.

This article may be out of date.

13th February 2008

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Investors are often attracted to super because of its tax concessions.  In fact a very good argument can be made that without these tax concessions there is very little about superannuation which is attractive.  Unsurprisingly a common question we often get asked is, if I've done anything wrong whilst running a super fund could the fund lose its tax concessions and what other penalties might apply if it does?

Under the superannuation laws a fund will receive tax concessions if it passes a number of compliance tests.  These tests are different for Self Managed Super Funds and non-SMSFs.

A non-SMSF, which includes small APRA funds – that is small funds which are run by specialized trustee companies, must get through three distinct rules.

Firstly it must be a regulated super fund which means the trustee has irrevocably elected to be bound by the super rules.

Secondly the fund must be a resident super fund which means it satisfies a number of other tests which include examining if a fund is managed in Australia and also if most of the fund's members and their assets are based in Australia.

The third rule demands that a non-SMSF must at all times comply with all the superannuation laws.  The super laws are far too complex for any super fund to comply at all times with them.  The law recognizes this and requires non-SMSF trustees to tell the Australian Prudential Regulation Authority about any compliance breaches.  APRA will only then take away a non-SMSF's compliance status – and will therefore face tax penalties – if the fund fails the "culpability test".  We won't look at this test in too much detail except to note that the test will be failed if all fund members knew about any super law breach or those members who were ignorant about a breach would not suffer any substantial financial detriment if the fund was made a non-complying fund.  In reality this test is highly unlikely that any non-SMSF would fail this test.  As a result since the current super laws were first introduced in 1994 non non-SMSFs had been made non-complying.

What compliance tests apply to SMSFs?  SMSFs must also be a resident super fund and a regulated super fund.  SMSFs however do not have a culpability test.  If a SMSF fails to satisfy all the super rules it has to tell the tax office – the SMSF regulator – about the breach in the fund's annual regulatory return.  The law then asks the ATO to look at a breach and to take away a fund's complying status only after the ATO has considered the breach's gravity, the tax impacts of taking away the fund's complying status and also anything else the ATO believes is relevant.

In reality the ATO declares all SMSFs to be complying super funds and allowed tax concessions until the ATO decides that the fund's trustees have been sufficiently naughty to take away the fund's tax concessions by declaring the fund non-complying.

What process does the ATO follow to decide if a fund should be declared non-complying?  The ATO has issued a Practice Statement (PS LA 2006/19) which tells its staff what administration process they must follow.  The ATO will look at the behaviour of a trustee (was the mistake deliberate or an honest mistake), how a breach has impacted the fund’s assets, if the trustee’s actions have exposed the fund’s assets to unreasonable risk, the number and duration of the breaches and the nature of the breach in the overall scheme of the super laws.

Other relevant information which might be considered include – has the trustee fixed up the breach, the skill and knowledge of the trustee, the compliance history of the fund before the breach occurred and the events which led to the contravention.

Some readers want to know why there is a different system for non-SMSFs and SMSFs.  Before 1994 all super funds operated under a system which was similar to that which currently applies to SMSFs.  The government of the day recognized that this system ultimately meant that arm's length members who were not involved in a trustees decision or the operation of the fund would be unfairly penalized if their fund's compliance status was removed and therefore faced tax penalities.  They solved this dilemma by introducing the culpability test which applied to all funds until 1999 when the old system was re- introduced for SMSFs.

The potential penalties that apply is also worth noting.  In the financial year a fund’s complying status is removed it effectively looses half its assets in tax penalties.  In each subsequent year that it remains non-complying its income will be taxed at 46.5%.

The super laws also give the super regulators a wide range of additional options in how they might want to fix a problem.  The ATO could accept an undertaking from a fund trustee to fix up a contravention of a law, disqualify the trustee, suspend or remove the trustee, freeze super fund assets if member benefits may be lost or reduced and lastly seek civil or criminal penalties through the courts against those involved in the breach.

A SMSF trustee who thinks they can run their fund and blithely ignore this regulator arsenal needs to have their head examined.

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