Remember the early noughties? The economy was booming. You and your wife were living it up. Your successful mining and construction contracting business is generating huge profits. You were buying up properties all over the place – all negatively geared to the hilt to save tax.

All of a sudden, your dreams are shattered in an instant.

“World Equity Markets Face Global Financial Meltdown” is splashed across the front page of every newspaper. The stress of it all causes you to suffer from depression and anxiety disorders. This affects your ability to manage the company's operations. Your business starts to suffer. The company is now under serious financial pressure. Suppliers withdraw credit and demand cash payment up front. To cap it off, your bank hangs you out to dry – they decline further finance, despite your 15 years of loyal patronage to them.

Let’s look at the facts:

• The loan was in excess of 5% in house asset limit.
• Sadly, the Auditor was required to lodge a contravention report. The ATO gratefully received it.
• Our friends at the ATO, always willing to rub your nose in it, decided to render the whole fund non-complying.
• This decision was made despite the enormous difficulties faced by the company.
• The company did eventually pay back the entire outstanding balance, but this did not mitigate their punishment.
• The SMSF trustees sought a review of the Commissioner of Tax’s mean spirited decision not to exercise his discretion under the superannuation laws. If the ATO felt nice that day, they could have treated the fund as a complying fund despite the contravention of the in-house assets rules.
• It was argued that the ATO did not give enough weight to the personal hell the husband and wife were in.  Also, too much weight to the seriousness of the breach.
• Somewhat surprisingly the AAT dismissed this argument and found in favour of our friends at the ATO.

What does this mean?

• Once a fund is deemed non-compliant, it loses its complying status. It also loses access to concessional tax treatment. Its taxable income is assessed at the top marginal rate of 45%.

This is a severe penalty that anyone operating a fund must be aware of.

For our much loved Platinum Members, we set out the market value ratio rules here. We also let you know what to do when your assets halve in value and breach the 5% exemption rule.

ATO warning to fund trustees

The decision is a reminder to trustees to act urgently to remedy breaches. Fail to do this and the ATO hunts you down. Most breaches of the SIS Act can be rectified with minimal impact on the trustees of the fund.

Be aware of the rules

Take careful heed of this decision. Yes, the Commissioner has discretion available to him under the law to treat a fund as complying, notwithstanding that the fund has contravened the law. But the exercise of that discretion depends on the circumstances of each case. It should not be taken for granted.

The ATO had no sympathy for this guy. That point is clear. In my 23 years of practicing, I have never seen the ATO on any one of my files inflict such a harsh penalty of 45%. Normally, it is a much smaller % penalty or a stern warning.

It shows that if you try to do the right thing and not be too cute, you can get away with more. Rub the ATO up the wrong way and it could backfire on you.

Running a self-managed super fund can bring great benefits, but be aware of the rules.

If you are concerned, or want to know more seek legal advice early rather than later. The sooner you sort it out, the better things will be in the long run. I am here to help. So contact me, Brett Davies on (08) 9460 5046, or after hours on 0419980972. My specialist SMSF and Tax team are on permanent standby.

Build these documents now:

• Investment Strategy for Self Managed Super
• Product Disclosure Statement (general)
• MySF Manager - DIY Edition (SMSF Software)
• Product Disclosure Statement (Pension only)
• Self Managed Superannuation Fund Deed 
• SMSF - Guide to Transacting with your own Fund

Read these Bulletin Bookshelf articles now:

• ATO conducting audits Christmas Day
• Strategies to test if a Super Fund is up-to-date
• Your SMSF - farce and formalities
• Make love, not war - to your auditor