29/09/2009

Trustees of SMSFs may well be forgiven for thinking notices of non-compliance are never issued by the Tax Office.  Certainly, the Tax Office has made clear it will issue such notices as a last resort only.   However, the recent decision by the Administrative Appeals Tribunal in JNVQ v Commissioner of Taxation in which the Tribunal upheld a Tax Office decision to issue a non-compliance notice provides trustees with a timely reminder of the importance of super law compliance.

The facts

A husband and wife were the members and trustees of a self managed super fund.  In August 2004, the trustees entered into a loan agreement with a company controlled by the husband.  At that time, the husband was suffering a chronic illness and the company was under financial strain due to market conditions and cyclone damage to its business premises.  Without the fund lending money to the company, it would have become insolvent.  The parties intended the loan to provide temporary relief only and all money lent by the fund would be promptly repaid.

Under superannuation law, a loan by the fund to a related entity is classified as a type of “in-house asset”. By law, trustees must ensure that, at any time, no more than 5% of the fund’s assets may be classified as in-house assets.

In this case, the total value of money lent to the company amounted at one point to more than 95% of the fund’s assets.  The trustees were therefore in breach of the in-house asset rules.

The fund’s auditor notified the Tax Office of the breach in July 2007.  The loan was not fully repaid by the company until March 2009. In the interim, the husband and wife had made investments in other enterprises.

Non-compliance

The Tax Office issued a notice of non-compliance to the trustees on 15 July 2008.  The effect of the notice was to remove the concessional tax treatment of the fund so that fund income would be taxed at 45% and not 15%.  The value of the fund’s assets in the year in which the fund became non-complying would also be taxed so as to recover all the previously available concessions.

The trustees sought review of the Tax Office’s decision by the Tribunal. On review, the Tribunal upheld the Tax Office’s decision.  The Tribunal considered the breach sufficiently serious to warrant the issue of the non-compliance notice, despite the resulting adverse tax consequences for the fund.  The particular aspects that drove the Tribunal’s decision appear to be the value of the loan (more than 95% of the fund’s assets), the time taken by the company to repay the loan and that fact that the husband and wife had pursued other investments with funds that may have been used to repay the company debt.

The moral of the story? Several rules can be drawn from this case:

Trustees must maintain funds in accordance with super legislation. If a trustee breaches super legislation, he or she should take immediate steps to rectify the breach.  The steps should be taken before action is taken by the Tax Office. The Tax Office and Tribunal may have regard to personal circumstances which give rise to a breach (eg illness or financial distress) in determining whether a non-compliance notice is appropriate.  However, consideration will also be given to the seriousness of the breach, having regard to factors such as the time taken to rectify the breach, the fund’s compliance history and the trustee’s attitude. The Tax Office will issue a notice of non-compliance as a last resort only.  Accordingly, trustees may have an opportunity to co-operate with the Tax Office to decide how a breach best be rectified.  Trustees should co-operate so far as possible with the Tax Office. Put simply, if trustees are provided a lifeline, they should use it!