Self Managed Super Fund lends money to related company, pays 45% tax

The Administrative Appeals Tribunal has upheld the decision of the Tax Office (ATO) to make a Self Managed Superannuation Fund (or 'SMSF') 'non-complying' when it breached the investment rules applying to SMSF's.

Editor: For SMSF's to access the concessional tax treatment that superannuation offers (such as the 15% tax rate), funds must be 'complying' funds. That is, the funds must comply with the superannuation law, including the restrictions on what they can invest in. If a previously complying fund is made 'non-complying' by the ATO, it may need to include the full market value of its assets in its income that year and it is all taxed at 45% (in that year and all future years the fund remains non-complying).

Facts
In the 2004/05 income year, the SMSF (the 'Fund') made loans to a company which was a related party of the Fund.

Editor: Under the investment restrictions in the superannuation law, a loan to a related party is considered an 'in-house asset', and an SMSF is limited to basically having no more than 5% of its assets as in house assets.

The trustee's actions resulted in the fund lending almost all of its assets to the related party, above 95% - well beyond the allowed 5%. On 23 July 2007, the Fund's auditor lodged a contravention report with the ATO advising the Fund had contravened the in house asset rules. The ATO consequently issued a non compliance notice in respect of the Fund, and the trustees appealed the decision to the Tribunal.

They argued that the Fund should still be treated as complying despite the contravention of in house asset rules, due to other factors, such as the declining fortunes of their business operations at the time, the chronic illness of one of the trustees (who was also the company manager), and the Queensland cyclones in 2004 and 2005.

Reasons for Decision
The Tribunal Considered:

• the taxation consequences arising from treating the Fund as non-complying;
• the seriousness of the contravention (the Tribunal member considered the contravention very serious, and stated "I doubt that the (trustees) even now appreciated its seriousness"); and
• all other relevant circumstances.

However, the Tribunal held that  "it was the correct decision to issue the notice of non-compliance."
The seriousness of the contravention, and the length of time taken to redress it, "weighed most heavily" against treating the Fund as complying despite the contravention of the Act.

Editor: Before issuing the non-compliance notice, the ATO rejected two repayment arrangements the trustees put forward because the time frames were too long. Had they been able to rectify the breach in a more timely fashion, the Fund may not have been made non complying.

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