Cases show breaching superannuation rules can be costly

A superannuation flavour this week. The growth of superannuation is now well documented, but with that comes a warning about complying with the rules that govern super. And there are, as we all know, plenty of them!

I’ve picked out three recent decisions, one by the Federal Court and two by the Administrative Appeals Tribunal, that graphically illustrate the results when the rules concerning superannuation are not complied with – and those results can be costly. They are a timely reminder to SMEs to tread carefully when dealing with their superannuation.

Sole purpose test: $15,000 penalty

The superannuation laws contain what is known as a sole purpose test, which basically means that a super fund must be run for the sole purpose of providing certain benefits to fund members. Failure to meet this test means a fund would become non-complying and lose its concessional tax treatment.

In a recent case before the Federal Court, the Court imposed a $15,000 civil penalty on a trustee of a self-managed super fund (SMSF) for the unauthorised early release of benefits in breach of the sole purpose test.

After establishing the single member fund in July 2005, the trustee progressively withdrew benefits in small transactions for his personal use totalling $75,570 over the period 2005 to 2008.

The auditor of the fund identified the unauthorised withdrawals (representing 98% of the assets of the fund) which were reported in the fund’s accounts as loans to the trustee. The auditor duly reported the contraventions to the Tax Commissioner.

The Tax Office applied to the Federal Court to impose a civil penalty on the trustee.

The Federal Court held that the trustee had contravened the sole purposes test through the multiple unauthorised withdrawals contrary to the fund’s governing rules and the superannuation law. The Court said the trustee had instead caused the fund to be maintained as a source of unauthorised early access to satisfy his living expenses. The Court was also satisfied that the trustee breached the superannuation laws by giving financial assistance to a fund member using the resources of the fund.

The Court imposed a civil penalty of $15,000 (plus costs of $5,000), to be paid in weekly instalments over two years, after finding that the contraventions were “serious” so as to warrant a monetary penalty.

In fixing the civil penalty (which could have been a maximum penalty of $220,000), the Court considered that a monetary penalty needed to be sufficiently high to deter contravention by others, but not so high as to be oppressive. In this respect, the Court agreed that a $15,000 penalty, as proposed by the parties, was within the range appropriate in the circumstances. The Court said the contraventions were deliberate and involved sizeable amounts over a period of years that deprived the super fund of its total assets.

The Court took into account the trustee’s capacity to pay such a significant penalty, having regard to his personal circumstances, including the financial pressures surrounding his divorce. While the trustee had a good income as a fruit and vegetable vendor, the Court acknowledged that much of it was committed to mortgage payments, child support and repaying the tax debt following the reassessment of his taxable income to include the unauthorised early withdrawals.

Importantly, the Court also acknowledged that the trustee had cooperated in the proceedings and no third parties suffered loss. However, the Court took into account the fact there were 160 deliberate contraventions over a sustained period during which he benefited personally. The penalty was not insignificant but it could have been much higher. The offences in question are taken seriously by the courts, so SMEs with such super funds are on notice.

The Court also warned super fund trustees that providing for retirement through a SMSF is a privilege that should not be abused.

Personal super contribution – penalty remitted

Under the tax law, self-employed people are entitled to a tax deduction for their personal superannuation contributions provided certain conditions are met. Failure to meet these conditions means a penalty can be imposed.

In a recent case before the Administrative Appeals Tribunal (AAT), a penalty was correctly imposed but was remitted. Mr Johnston sold an investment property in 2007 and sought to use the sale proceeds to make personal superannuation contributions over several years. However, he was denied a tax deduction due to his failure to give the trustee of his superannuation fund a notice of his intention to claim the deduction within the strict time limit under the tax law. That time limit meant he had to provide the notice to the fund by the time he lodged his tax return for the year in which the super contribution was made.

However, he did not lodge the notice for the 2008 income year until July 2010, after the Tax Office queried his tax deduction claims. The Tax Office imposed a 25% penalty for not providing the notice within the required time.

The AAT remitted the penalty in full. It said that the 25% administrative penalty was properly imposed by the Tax Commissioner due to a failure of Mr Johnston’s tax agent to take reasonable care. However, the AAT remitted the penalty in full after finding that it would be “harsh” for Mr Johnston to pay a penalty of $10,000 on top of the $40,000 increase in his tax bill due to a shortcoming in the paperwork.

The AAT also noted that the requirement to provide a notice of intent to claim a deduction “is not particularly well highlighted in the public material dealing with the tax treatment of superannuation contributions”. As a result, it found that the invalid tax deduction claim was not attributable to a failure on Mr Johnston’s part to take reasonable care. However, according to the AAT, reasonable care on the part of the tax agent for such a significant deduction should have triggered an enquiry to confirm from Mr Johnston that the administrative requirements to support the claim had been complied with.

So this was an escape for the person concerned, but the warning remains about the need to comply with the law. The AAT’s comments about the lack of publicity given to the need to notify a super fund when a personal super contribution is to be made should also be noted.

Superannuation excess contributions tax assessment upheld

There are caps or limits on the amount of superannuation contributions that can be made in any given year. The rationale is an attempt to curtail the accumulation of so-called “excessive superannuation benefits” in the concessionally-taxed superannuation environment following the abolition of end benefits tax for those 60 and over. But these caps present problems.

Contributions above the annual contributions limits are subject to excess contributions tax levied on the individual. This tax can amount to 93%! The laws contain strict provisions about the levying of this penalty which have been widely criticised – in essence, if the caps are exceeded, the Tax Commissioner basically has no discretion to waive the penalty.

In a recent case, the AAT upheld a superannuation excess contributions tax assessment against a taxpayer for breaching the $1 million non-concessional contributions cap during the transitional period to June 30, 2007.

The Tax Commissioner issued the taxpayer with an excess non-concessional contributions tax assessment of $86,867 for the 2007 income year in respect of non-concessional superannuation contributions totalling $1,186,811.

The taxpayer objected against the assessment claiming that a payment of $355,000 from her personal superannuation fund was received by her in a capacity as trustee (and not beneficially in her personal capacity) before being on-paid to the iAccess Superannuation Fund (IPAC Fund). The taxpayer originally intended that the $355,000 would be paid directly from her personal superannuation fund to the IPAC Fund. However, she allegedly received independent professional advice to implement the transaction by drawing a cheque from her personal superannuation fund in her favour (deposited to her account), followed by a bank cheque drawn by her in favour of the IPAC Fund.

The taxpayer argued that, as she received the $355,000 amount as a bare trustee, it was a “roll-over superannuation benefit” and not an eligible termination payment (ETP).

The Tax Commissioner considered that the taxpayer intended the $355,000 to be an ETP (rather than a roll-over) as part of a re-contribution strategy which inadvertently breached the transitional $1 million non-concessional contributions cap. The Commissioner also noted that the taxpayer’s personal superannuation fund, of which she was the sole director of the corporate trustee, had reported the $355,000 amount as a benefit. The taxpayer had also included the ETP in her personal tax return.

In upholding the assessment, the AAT said there was no doubt that the $355,000 was in fact received by the taxpayer from her personal superannuation fund and treated by her as an ETP before being on-paid to the IPAC Fund as a non-concessional contribution.

The AAT dismissed the taxpayer’s argument that the payment from her personal superannuation fund was received by her in a capacity as trustee (and not beneficially in her personal capacity). The AAT said there was no basis upon which the taxpayer could now seek to contend that the amount was not derived by her legally and beneficially before being on-paid to the IPAC Fund as a non-concessional contribution.

As the taxpayer had treated the payment to her as an ETP and accounted for it in this manner, the AAT held that the amount paid to the IPAC Fund could not be treated as a “roll-over superannuation benefit”. The AAT said the difficulty which confronted the taxpayer in this case was that the payment was not made by a complying superannuation plan to another complying superannuation plan. For this reason, the relevant transaction could not be treated as a roll-over.

These three cases illustrate the difficulties that members of super funds can get into. The laws surrounding superannuation are voluminous and often complex, and the penalties for breaching those laws are substantial. SMEs need to be careful when dealing with their superannuation.

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions .

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