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Page last updated Friday, 05 February 2010
Self Managed Super Funds Bulletin - Issue 57: February 2010
Recent times have seen a significant increase in the number of self managed superannuation funds (‘SMSF’) being rendered non-complying.
|
2007 |
2008 |
2009 |
SMSFs made non-complying |
5 |
24 |
99 |
The government states that the ‘increase in the number of compliance outcomes in recent years is primarily due to an increase in the number and intensity of compliance activities being undertaken by the ATO, rather than a deterioration in compliance behaviour.’ This article discusses the key issues and provide a number of practical tips.
Receiving a notice of non-compliance from the ATO usually has devastating tax consequences. These include:
The pension exemption is not available.
General interest charge is also usually payable on the above. The interest accrued can be substantial where the ATO issues the notice of non-compliance in respect of a financial year that has long past.
Consider the following case study.
In 2007 financial year, Joey made a $1 million undeducted contribution to a brand new SMSF. By 30 June 2008 the market value of the SMSF has grown to $1.7 million. On 1 July 2008 the SMSF commences using all of its assets to pay Joey a pension. During the 2009 financial year, the SMSF receives $100,000 of interest payments.
The amount of tax payable by the SMSF if it continues to be a complying superannuation fund with 100% of its assets in pension mode is as follows:
Income from assets set aside to meet current pension liabilities: $100,000
Less adjustment for ‘pension exemption’ ($100,000)
Total assessable income –
Taxable income –
--------------
Tax payable (ie, taxable income x 15%) –
However, if the SMSF received a notice of non-compliance in respect of the 2009 financial year, the amount of tax payable is as follows:
The market value of the SMSF as at the end last financial year $ 1,700,000
Less undeducted contributions ($1,000,000)
Income from assets set aside to meet current pension liabilities: $100,000
Total assessable income $800,000
Taxable income $800,000
--------------
Tax payable (ie, taxable income x 45%) $360,000
A general interest charge would also apply and this could in some cases result in almost double the amount payable if five or more years have elapsed since the breach occurred.
Many SMSFs are rendered non-complying pursuant to the following process.
Firstly, the SMSF’s auditor lodges an auditor contravention report (‘ACR’). (ATO publication NAT 11299 contains a handy summary of the ATO’s views on when ACRs need to be lodged.)
The ATO mails ‘notification of audit for your action’ to the trustee (usually care of their tax agent) asking for more information within say one month. This outlines, amongst other things, the ATO’s aim to complete an audit within a given period (eg, three months).
Subject to the information received from the trustee, the ATO might form the view that a contravention did occur. Assuming that the SMSF met the definition of ‘Australian superannuation fund’, the ATO has a discretion on whether to issue a notice of non-compliance.
If the ATO are considering issuing a notice of non-compliance, they generally send a position paper explaining their reasons. The ATO typically provides the trustee the opportunity to submit reasons why the fund should not be made non-complying.
Subject to the response received, the ATO will either issue the notice of non-compliance and then amended assessments will follow or accept the reasons (but invariably request further evidence to support of a trustee’s reasons).
Broadly, the trustee may request a review of the decision or may appeal to the Administrative Appeals Tribunal. Note, the ATO’s decision to issue a notice of non-compliance is reviewable and an income tax assessment then follows. Thus, both a request for a review of the ATO’s decision and an objection against the assessment are generally required. Trustees must act swiftly as they only have 21 days to request a review but 4 years to lodge an objection. In practice, a request for an extension of time is invariably required due to this short time frame.
Just because a contravention has occurred, does not necessarily mean that the ATO will issue a notice of non-compliance. As set out in ATO Practice Statement Law Administration 2006/19 at paragraph 12, the ATO have many options where a contravention has occurred, including:
One notable exception to the ATO’s discretion is where the SMSF has failed to meet the definition of Australian superannuation fund in s295-95(2) of the ITAA 1997. If an SMSF fails to meet this definition, the ATO must issue a notice of non-compliance and there is little point in objecting against such an assessment or seeking a review by the AAT as the legislation provides no discretion, ie, if a fund fails the definition of Australian superannuation fund the tax liability automatically applies: see s295-320 ITAA 1997.
This was illustrated in the recent AAT decision of CBNP Superannuation Fund and Commissioner of Taxation [2009] AATA 709. In this decision the SMSF’s auditor lodged an ACR regarding a perceived contravention of the ‘in-house assets’. Upon investigating, the ATO appeared to disregard the in-house asset breach but had detected that the SMSF was not a resident superannuation fund (note that from 1 July 2007 the concept of a resident superannuation fund has been replaced with Australian superannuation fund). As the ATO had no discretion on this point, the ATO issued a notice of non-compliance, which the taxpayer requested review by the AAT. The AAT found that although the SMSF member’s situation was ‘most unfortunate’, the notice of non-compliance had to stand because the SMSF did not satisfy the definition of resident superannuation fund.
The ATO consider a number of factors in deciding to issue a notice of non-compliance. As set out in ATO Practice Statement Law Administration 2006/19 at paragraph 34, these factors include:
In light of the first factor above in particular, whenever a contravention occurs, the trustee should always endeavour to rectify any contravention as soon as possible. Thus, if an ACR must be lodged, it is ideal if it can also confirm hat the contravention has already been rectified.
If the contravention is not rectified when the ACR is lodged, the trustee should consider offering a written undertaking to the ATO. When and if a written undertaking is accepted by the ATO, it becomes enforceable. If the Trustee breaches a term of that undertaking, the ATO can apply to a court for an order in relation to the breach. Acceptance of an undertaking by the ATO may be an alternative to the fund being rendered non-complying. The authors have had success with numerous breaches in which the enforceable undertaking was instrumental in obtaining the ATO’s exercise of discretion.
However, it is important to note that just because an undertaking is offered, does not mean that ATO will necessarily accept it. As set out in ATO Practice Statement Law Administration 2006/18 at paragraph 19, in determining whether to accept an undertaking offered, the ATO will consider the following:
Another major factor that the ATO take into account is the time frame offered in any undertaking. The longer the time frame offered, the less likely the ATO is to accept it. This was illustrated in JNVQ and Commissioner of Taxation [2009] AATA 522. In this matter more than 95% of the SMSF’s assets had been lent a related party. In the first undertaking offered (made in February 2008) the trustee proposed to have the loan fully repaid by 30 June 2010 (approximately 2.5 years). The ATO rejected this. In the second undertaking offered (made in June 2008) the trustee proposed to have the loan fully repaid by 30 November 2008 (ie, 5 months). This very short time frame was also rejected by the ATO. The AAT noted that:
The [ATO] declined each proposal. As appears from the [ATO]’s reasons for refusing these offers, the [ATO] considered the timeframes were set too far into the future.
When contraventions are identified, they should be rectified immediately or as soon as possible. If an ACR needs to be lodged, it is ideal if the report can detail a ‘happy ending’ (eg, yes a contravention occurred, but the trustee diligently rectified and have taken the following steps to ensure that it never happen again ...).
If it is not possible to rectify before the ACR is lodged, an undertaking should be offered to the ATO detailing how the contravention will be fixed in the shortest possible time frame.
If it is not possible to offer an undertaking, then a suitable request should be made which seeks to position the fund in the best light and to obtain the ATO’s favourable exercise of discretion.
If a request for review and an objection is required, the trustee should ensure they have all grounds and supporting information covered and seek to co-operate with the relevant ATO officers to preserve the fund’s complying status.
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