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ZDDD and Commissioner of Taxation [2011] AATA 3 (10 January 2011)

Last Updated: 16 January 2012

Administrative Appeals Tribunal

DECISION AND REASONS FOR DECISION [2011] AATA 3

ADMINISTRATIVE APPEALS TRIBUNAL )

) No 2010/1651

TAXATION APPEALS DIVISION
)

Re
ZDDD

Applicant
And
COMMISSIONER OF TAXATION

Respondent

DECISION

Tribunal
Ms J L Redfern, Senior Member

Date 10 January 2011

Place Sydney

Decision
The decision under review is affirmed.

.................[sgd].............................
Ms J L Redfern
Senior Member

CATCHWORDS

TAXATION AND REVENUE – income tax – superannuation – complying superannuation fund – contravention of regulatory provisions – notice of non-compliance issued – whether enforceable undertaking should be accepted – decision under review is affirmed

Income Tax Assessment Act 1936 s 109N, 288A

Income Tax Rates Act 1986 s 26

Superannuation Industry (Supervision) Act 1993 ss 3, 17A, 38A, 39, 40, 42A, 45, 62, 65, 109, 193, 262A

PS LA 2006/18 Self-managed superannuation funds – enforceable undertakings

PS LA 2006/19 Self managed superannuation funds – notice of non-compliance

Australian Securities and Investments Commission v Donald (2003) FCR 7; [2003] FCAFC 318

Re JNVQ and Commissioner of Taxation (2009) 74 ATR 730; [2009] AATA 522

Re XPMX and Commissioner of Taxation (2008) 73 ATR 925; [2008] AATA 981

Vivian (Deputy Commissioner of Taxation (Superannuation)) v Fitzgeralds & Anor (2007) 69 ATR 834; [2007] FCA 1602

REASONS FOR DECISION

10 January 2011
Ms J L Redfern, Senior Member

BACKGROUND

  1. The applicant is the corporate trustee of the K Superannuation Fund (the Fund). Mr K and Dr K are directors of the applicant and are members of the Fund. Mr K operates a legal practice (the law firm) and Dr K is a medical practitioner.
  2. The Fund was established on 22 May 1997 and has operated as a self managed superannuation fund since 8 October 1999. It was accepted as a “complying superannuation fund” by the Commissioner of Taxation for a number of years and as such enjoyed certain tax benefits available under the tax legislation.
  3. Between July and September 2008 the Commissioner of Taxation (the Commissioner) commenced audits of the Fund for compliance with the Superannuation Industry (Supervision) Act 1993 (the SIS Act) for the years ended 30 June 2005 and 30 June 2006. Those audits were completed in July 2009. The Commissioner formed the view the applicant had not complied with the regulatory provisions of the SIS Act and on 14 December 2009 issued a notice of non-compliance for the year ended 30 June 2005.
  4. The applicant requested a review of the decision, but on 1 April 2010 the Commissioner confirmed the notice of non-compliance.

ISSUES

  1. There is no dispute the applicant has breached a number of regulatory provisions of the SIS Act.
  2. The issue is whether, in the circumstances, the notice of non-compliance should be set aside and/or whether the applicant should nevertheless be given a notice stating it was a “complying superannuation fund” in respect of the income year ended 30 June 2005.
  3. A further issue arises whether an enforceable undertaking should be accepted as an alternative to the notice of non-compliance.

LEGISLATIVE FRAMEWORK

  1. The relevant legislation is the SIS Act, the Superannuation Industry (Supervision) Regulations 1994 (the SIS Regulations), the Income Tax Assessment Act 1936 (the ITAA) and the Income Tax Rates Act 1986 (the ITRA).
  2. The object of the SIS Act is “to make provision for the prudent management of certain superannuation funds” and for their supervision by the relevant regulators, which in this case, is primarily the Commissioner: s 3(1) of the SIS Act.
  3. Section 3(2) of the SIS Act provides:

The basis for supervision is that those funds and trusts are subject to regulation under the Commonwealth’s powers with respect to corporations or pensions (for example, because the trustee is a corporation). In return, the supervised funds and trusts may become eligible for concessional taxation treatment.

  1. Under s 17A(1) of the SIS Act, a superannuation fund will be a “self managed superannuation fund” if, relevantly where the trustee of the fund is a body corporate, the fund has less than five members and each director is a member of the fund.
  2. Section 40(1) of the SIS Act provides that the regulator, which in this case is the Commissioner, may give a notice to a trustee of the entity stating “whether the entity is or is not a complying superannuation fund ... in relation to a year of income specified in the notice”.
  3. An entity which was a self managed superannuation fund during a year of income is a “complying superannuation fund” in relation to that year if the entity is a “resident regulated superannuation fund”, which is not disputed, and passes the test set out in s 42A(5): s 42A(1) of the SIS Act.
  4. Section 42A(5) provides:

An entity passes the test in this subsection in relation to a year of income or part of a year of income if:

(a) no trustee of the entity contravened any of the regulatory provisions in relation to the entity during the year of income or the part of the year of income; or

(b) if a trustee of the entity contravened one or more of the regulatory provisions in relation to the entity during the year of income or the part of the year of income, the Regulator, after considering:

(i) the taxation consequences that will arise if the entity were to be treated as a non-complying superannuation fund for the purposes of the Income Tax Assessment Act 1997 in relation to the year of income concerned; and

(ii) the seriousness of the contravention or contraventions; and

(iii) all other relevant circumstances;

thinks that a notice should nevertheless be given stating that the entity is a complying superannuation fund in relation to the year of income concerned.

  1. The “regulatory provisions” for the purposes of s 42A(5) include provisions under the SIS Act and the SIS Regulations, but only apply to contraventions which are an offence or a contravention of a civil penalty provision under the SIS Act: s 38A and s 39(1) of the SIS Act.
  2. A fund is a “complying superannuation fund” for the purposes of the ITAA if the Commissioner has given notice the fund is complying and has not subsequently given a notice of non-compliance: s 45 of the SIS Act.
  3. The ITRA provides concessional rates of tax for a trustee of a complying superannuation fund: s 26(1). In addition, if a superannuation fund is found to be non-complying but was complying in the previous year, the fund’s assessable income for the year includes the fund’s net income in respect of the previous years of income: s 288A the ITAA.
  4. In summary, a self managed superannuation fund that has been issued with a notice of compliance will be a complying superannuation fund, and will have the benefits of concessional tax rates, unless and until the trustee is served with a notice that it is non-complying. Once a self managed superannuation fund is served with such a notice, concessional rates will no longer apply and tax will be assessed on net funds in the previous income years as well as on income in the current year of assessment.
  5. It is common ground that there are significant tax consequences if a complying self managed superannuation fund becomes non-complying as a result of the issue of a notice of non-compliance by the Commissioner. In the present case, an amended assessment dated 22 July 2010 has been issued to the applicant for the year ended 30 June 2005 as a result of the audit in the sum of $92,348.35.
  6. It is also common ground that in the income year ended 30 during 2005, the applicant contravened three regulatory provisions of the SIS Act; being ss 62(1), 65(1)(b) and 109(1) of the SIS Act.
  7. Section 62(1) requires a regulated superannuation fund to be maintained solely for one or more of the core purposes specified in s 62, namely for provision of benefits to members upon their retirement (or their dependants in the case of a member’s death before retirement). Section 65(1)(b) prohibits a trustee of a regulated superannuation fund giving financial assistance using the resources of the fund to a member or relative of a member of the fund. Section 109(1) requires investment of a superannuation entity to be made on an arm’s length basis.
  8. These regulatory provisions are civil penalty provisions under s 193 of the SIS Act.
  9. Under s 262A of the SIS Act, the Commissioner may accept a written undertaking given by a person in connection with a matter in relation to which the Commissioner has a power or function under the SIS Act. The written undertaking is enforceable in a court and is referred to as an “enforceable undertaking”. This provision is said to be relevant because an undertaking was offered by the applicant, but not accepted by Commissioner, prior to the issue of the notice of non-compliance. The applicant also contends an enforceable undertaking should be accepted as an alternative to the issue of the notice of non-compliance.

THE EVIDENCE AND CONTENTIONS OF THE PARTIES

  1. The Fund invested in the K Properties Unit Trust (the Properties Unit Trust) on 11 July 1997 and at all relevant times the assets of the Fund comprised units in the Properties Unit Trust. The trustee of the Properties Unit Trust is the applicant and the unit holders are the K Family Trust (the Family Trust) and the Fund.
  2. The financial statements for the Properties Unit Trust for the year ended 30 June 2005 show that as at 30 June 2004 the total assets of the unit trust were $413,617.39, comprising loans to the Family Trust and Mr K and “buildings - at cost” and plant and equipment totalling approximately $360,000. There is no dispute that the buildings and plant and equipment related to two properties owned by the Properties Unit Trust at Ashtonfield.
  3. Mr K gave evidence he commenced legal practice in the 1980s and, after growing his practice, employed a practice manager in 1996. He says the practice manager was charged with fraud related offences in respect of his legal practice after he discovered discrepancies in his accounts in late 1998. Mr K told the Tribunal that losses incurred as a result of actions by the practice manager and a decline in his business through poor health, left he and Dr K in a “precarious financial state” by the end of 1998. They became involved in a protracted legal dispute with their financier, National Australia Bank, but in July 2004 settled the litigation by refinancing with Bank West and paying the National Australia Bank $260,000. Under the refinancing arrangement, Bank West advanced $836,000 and these borrowings were secured over the properties at Ashtonfield and the property owned by Dr K at Wallsend.
  4. Mr K told the Tribunal he and Dr K were under significant financial pressure at this time and would have had to sell the family home at Wallsend to reduce the debt if the properties at Ashtonfield had not been sold. According to settlement statements produced by Mr K, the properties were sold in August and September 2004 for $438,000 and approximately $382,000 was paid to Bank West in reduction of the loan and approximately $38,000 was paid to the law firm.
  5. Mr K also told the Tribunal his financial position had improved since 2007, with fees from his law firm gradually increasing. However, he had been unable to repay the loan to the Properties Unit Trust and was not currently able to repay the loan.
  6. It is unclear from the evidence how much of the Bank West loan related to moneys owing on the Ashtonfield properties. However, it is common ground that part of the advance was used to discharge the debt of Mr and Dr K to the National Australia Bank and to refinance the law firm facility.
  7. This is consistent with the financial statements for the Properties Unit Trust for the year ended 30 June 2005, which show a reduction in the net assets for buildings and plant and equipment from $317,605 to nil and an increase in receivables, being a loan to Mr K for $190,410.70.
  8. The financial statements for the Properties Unit Trust for the period 30 June 2005 to 30 June 2009 show that no interest has been received on the loan to Mr K and the loan remains outstanding as a 30 June 2009.
  9. The financial statements for the Fund as at 30 June 2005 show investments in the Properties Unit Trust valued at $190,410, representing the value of the loan to Mr K. The financial statements for 30 June 2008 show that the financial position of the Fund is substantially unchanged since 30 June 2005.
  10. It is not disputed that funds in the Properties Unit Trust were paid to the benefit of Mr and/or Dr K in the year ended the 30 June 2005. It is also not disputed that the transaction and resulting loan to Mr K was not documented, was not on commercial terms and no interest has been paid or earned on the loan for the past 5 years. There is also evidence in the financial statements for the years ended 30 June 1999 to 30 June 2004 that the Properties Unit Trust made loans to or received loans from Mr K, the Family Trust or the law firm which were not on commercial terms.
  11. The applicant is the trustee of both the Fund and the Properties Unit Trust. The Commissioner contends that the applicant, by allowing the investment in the Properties Unit Trust and failing to ensure any income was received:
  12. Dr K told the Tribunal she was unaware of the financial arrangements between the Fund and the Properties Unit Trust. While she had signed documents from time to time, she had not understood the nature and extent of these financial arrangements. Dr K had only become aware of the dispute with the Commissioner and the Tribunal proceedings about two months before the hearing. It was her understanding she and Mr K owned the investment properties at Ashtonfield.
  13. It was Dr K’s evidence that the circumstances leading to the sale of the Ashtonfield properties followed a number of very difficult years for the family. The manager of the law firm had been convicted of fraud related offences, although the conviction was later overturned, and this experience had been a financial and emotional strain on both Mr and Dr K. Mr and Dr K had previously sold their family home at Hamilton to pay debts and purchased land at Wallsend to build a house. They borrowed money to build the house but Mr K also borrowed money to keep the legal practice going. By 2004 the ongoing dispute with the National Australia Bank and health problems in the family created financial pressures. The Mr and Dr K have four children ranging in age from 17 to 25 years old. Three are still dependents and the two youngest children are insulin dependent. Dr K has worked part-time as a general practitioner for 25 years. Both Mr and Dr K say they have not lived an extravagant lifestyle.
  14. In a supplementary statement to the Tribunal, which was not opposed by the Commissioner, Dr K acknowledged she had little understanding of her role as a director of the trustee of the self managed superannuation fund, but says she is willing to learn if she is given the opportunity. Dr K also states that she has since read publications from the Australian Taxation Office (ATO) in relation to self managed superannuation funds and the role and responsibilities of trustees and would like the opportunity to have a greater involvement as director of the trustee company in the future.
  15. The Commissioner commenced audits in relation to the Fund in 2008 and by letter dated 20 July 2009 to the applicant, a delegate for the Commissioner identified contraventions of the SIS Act, requested further information and notified the applicant the Fund may be made non-compliant unless the trustee rectified the contraventions.
  16. Mr K gave evidence that he instructed his accountant, Mr Joel Curry, to make a proposal to the Commissioner and by email dated 17 August 2009 Mr Curry proposed as follows:
  17. The Commissioner rejected the proposal and advised:

Although you have offered to pay interest on the loan from the unit trust to [Mr K] from this point in time, this is not sufficient to rectify the longstanding contraventions that have occurred. In addition [Mr K] continues to be in financial difficulties and, as an individual and as public officer of his company, has demonstrated a repeated inability to comply with payment arrangements that he has entered into.

Furthermore, we note your contention that when [Mr K] retires at 55 he intends to take a lump sum ETP on paper from the loan to clear the remaining balance of the investment in the unit trust. As you have currently valued the loan from the unit trust to [Mr K] at $190,392, and this represents the only significant asset of the fund -- the taking of any ETP that would clear the balance of the investment in the unit trust would involve [Mr K] taking a benefit equal to $190,391, when his interest in the fund is only $129,820 and [Dr K’s] interest in the fund is $54,794.27.

  1. A notice of non-compliance was issued on 14 December 2009 and by letter dated 28 January 2010 Mr Curry requested a review of the decision and an extension of time to respond. He reconfirmed the undertaking in the form proposed in his email of 17 August 2009 but advised the applicant was prepared to enter into an enforceable undertaking “to take whatever steps you feel appropriate to rectify the breach over time”.
  2. The Commissioner refused to withdraw the notice. One of the issues raised was the failure of the applicant to propose a rectification plan that adequately rectified “longstanding contraventions”.
  3. Mr K gave evidence that the applicant was prepared to provide a further undertaking to the Commissioner that he would pay $100,000 to the Properties Unit Trust by mid-December 2010 with the balance of his loan repayable over five years with interest at 7.5% commencing on 10 November 2010 secured by an unregistered mortgage over the Wallsend home. A formal undertaking was offered to the Commissioner, and provided to the Tribunal, by letter dated 21 October 2010.
  4. In summary, the undertaking provides as follows:
  5. It is contended by the applicant the notice of non-compliance should be set aside and the proposed enforceable undertaking should be accepted as an alternative. The circumstances that gave rise to the contraventions of the SIS Act were exceptional. The tax consequences of not withdrawing the notice of non-compliance are significant such that the Fund and the applicant may become insolvent. This would not be in the best interests of the members of the Fund. The contraventions are serious but at the “low end” of the scale and the applicant and the directors have proposed new undertakings to rectify the contraventions, which should be accepted. The contraventions were not intentional and Mr and Dr K, as directors of the trustee, did not have sufficient skill or knowledge to understand the SIS Act or the role and responsibilities of trustees of a self managed superannuation fund. The Commissioner has stated the ATO will focus on “education to encourage voluntary compliance”, but the applicant contends the ATO has “failed in its obligation to educate Trustees” by failing to provide training courses to trustees and failing to ensure information about self managed superannuation funds is proactively distributed.
  6. The Commissioner contends the notice of non-compliance should not be set aside. The scheme to provide tax concessions to self managed superannuation funds is a privilege that should not be abused, and is dependent on superannuation funds complying with certain key regulatory obligations under the SIS Act. These obligations are designed to encourage prudent management of retirement funds. The contraventions identified by the Commissioner, and conceded by the applicant, are serious and have resulted in the Fund holding an investment in a unit trust, the value of which has not increased since 2005, has earned no interest and is based on a loan that is not documented, includes no terms for repayment and is unsecured. The tax consequences are significant and the Commissioner accepts that adverse consequences may flow from the issue of the notice of non-compliance but contends this should be balanced against the seriousness of the contraventions and the trustee’s attitude to compliance with the regulatory provisions of the SIS Act.
  7. The Commissioner contends the new proposed enforceable undertaking is unsatisfactory and does not adequately address the Commissioner’s concerns or rectify the contraventions.

HOW SHOULD THE DISCRETION UNDER SECTION 42A(5) OF THE SIS ACT BE EXERCISED?

  1. Section 42A(5) gives the Commissioner discretion to issue a notice of compliance if a trustee of the superannuation fund has contravened one or more of the regulatory provisions of the SIS Act or SIS Regulations. The discretion requires the decision-maker to consider the tax consequences arising from the fund being treated as non-complying, the seriousness of the contraventions and all other relevant circumstances.
  2. The Commissioner has issued Practice Statement Law Administration (PS LA 2006/19) outlining the factors that will be considered in deciding whether a notice of non-compliance should be given to a superannuation fund where the trustee has contravened one or more of the regulatory provisions.
  3. While guidelines are not binding on the Tribunal, provided the guidelines are consistent with the provisions of the relevant legislation, they may provide useful insight for a decision-maker about the relevant regulatory issues, having regard to the experience of, and policy developed by, the regulator administering or enforcing the legislation.
  4. In the present case, PS LA 2006/19 draws substantially on the factors set out in the legislation, emphasises the discretion is an exercise in weighing up all relevant factors, but also identifies matters the decision-maker should consider when assessing those factors.
  5. The Commissioner contends that when exercising the discretion, the objects of the SIS Act should be taken into account. The Commissioner relies on the following comments of Logan J in Vivian (Deputy Commissioner of Taxation (Superannuation)) v Fitzgeralds & Anor (2007) 69 ATR 834; [2007] FCA 1602, which are instructive:

[25] Our parliament has deliberately constructed a scheme whereby, in return for submission to a regulatory regime found in the SISA, particular taxation benefits are given to the trustee of a superannuation fund and its members. The public policy that seems to underlie that particular concession is to encourage prudent provision by Australians for their retirement. In so doing, the burden on other taxpayers in the provision of social security benefits for the aged is thereby lessened. I can, I believe, responsibly take judicial notice that a contemporary phenomenon is a recognition that Australia has, in terms of its demographics, a need for such provision to be encouraged.

[26] Part of the scheme found in the legislation is to enable what one might term small funds or, at least, funds which have fewer than 5 members to be self-managed. That is a particular benefit conferred by the parliament on those who would wish to make provision for their retirement. It enables self-management as opposed to becoming a member of a fund the management of which may be remote from membership. It is a privilege. It is a privilege that should not be abused...

  1. There are three factors that must be considered under s 42A(5) of the SIS Act and PS LA 2006/19 provides guidelines to the decision maker on each of these factors. In my view, PS LA 2006/19 is consistent with these objectives.

TAX CONSEQUENCES

  1. PS LA 2006/19 recognises that the decision to change the status of a self managed superannuation fund from a complying fund to a non-complying fund will have a significant financial impact on the fund. Whether it would be reasonable to treat a non-complying fund as complying is said to depend on:

... the particular circumstances of the case, the seriousness of the contravention, and the trustee’s attitude to complying with the regulatory provisions.

  1. The applicant contends the tax consequences are so serious that in the circumstances of this case, they should be accorded greater weight than the contraventions which are, according to the contentions of the applicant, at the “low end” of the scale in seriousness.
  2. I accept the tax consequences are significant and the applicant may be unable to pay the tax debt, which may lead to liquidation of the Fund. The sole asset of the Fund is the investment in the Properties Unit Trust, which may not be recoverable in any event, as the sole asset of the unit trust is a loan to Mr K, which he says he cannot repay.
  3. This illustrates the problem. The Commissioner contends the contraventions are serious as they have exposed the Fund to risk. The investment cannot be realised or diversified and is dependent on Mr K repaying his loan. Recovery of the investment and the recovery of any tax liability both depend on the ability of the Properties Unit Trust to recover a substantial debt from Mr K.
  4. In the circumstances of this case, I am not convinced the tax consequences of the notice of non-compliance outweigh other factors, including the seriousness of the contravention.

SERIOUSNESS OF THE CONTRAVENTIONS

  1. Under PS LA 2006/19, the following factors should be considered when assessing the seriousness of the contravention:
  2. The evidence of Mr and Dr K is that the contraventions were inadvertent and based on a lack of understanding about self managed superannuation funds and the roles and responsibilities of trustees.
  3. However, the evidence raises some serious concerns. Dr K did not know she was a director of the applicant and did not know the investment properties at Ashtonfield were assets of the Properties Unit Trust.
  4. Mr K understood he was a director of the applicant but gave evidence that the Fund was the owner of the investment properties at Ashtonfield. He also gave evidence that in 2004 he did not consider the question of whether selling the Ashtonfield properties would affect the value of the Fund and did not understand the purpose of the Properties Unit Trust.
  5. In 1999 the Ashtonfield properties were used as security to borrow the funds used to build on the Wallsend property owned by Dr K. Mr K acknowledged the Ashtonfield properties were used for the benefit of the family in building the Wallsend home, but said that at the time he “did not think there was anything against doing that”.
  6. There were loans recorded in the financial statements for the Properties Unit Trust for 30 June 2001 to the Family Trust beneficiary and to Mr K totalling $63,779.58. Mr K did not know what the loans were for, but told the Tribunal that he did not consider the impact of those loans on the financial position of the Fund.
  7. Mr K did not agree, as was put to him by counsel for the Commissioner, that the Fund was a sham, although he acknowledged there was “interchangeability” between assets of the Fund and the family’s assets. Mr K believed he could use the assets of the Fund for the benefit of the family and did not see any difference between the assets that were held in the fund, and his own assets. Mr K later qualified this by saying he believed he and his wife could have access to the superannuation funds in the circumstances.
  8. Mr K also gave evidence he would not have examined the financial statements for the Fund or the Properties Unit Trust for the year ended 30 June 2005 and would have signed these financial statements on the advice of his accountant.
  9. In summary, the evidence is that assets in the Properties Unit Trust, which is the sole asset of the Fund, were used by the family from at least 1999 until 2005 for their benefit. There was no consideration of the effect on the value of the units in the Properties Unit Trust yet Mr and Dr K, who were directors of the applicant which was trustee of both the trust and superannuation fund, were in the position to make decisions affecting both entities.
  10. I accept Mr and Dr K, as directors of the applicant, did not understand these were contraventions of the SIS Act because they lacked experience in this area. On the other hand, they did not seek advice or adequately inform themselves about the role of a trustee of a self managed superannuation fund and relied on their accountants. However, the duties of a director cannot be delegated to advisers. While it may be appropriate for a director to rely on the advice of others, indeed, this is recognised by s 189 of the Corporations Act 2001, directors must make their own enquiries and independent assessment of that information or advice. As acknowledged by the Commissioner, the ATO does have a role in educating taxpayers and trustees of self managed superannuation funds about taxation and superannuation laws, but does not have an obligation, as submitted by the applicant, to ensure trustees understand and comply with the law. In my view, the primary responsibility for this obligation resides with trustees and if the trustee is a corporate trustee, those who manage them.
  11. In 2004 the Commissioner published a document called “DIY Super. It’s your money ... but not yet!” This document was available on the website and a hard copy was sent to trustees who raised an issue about self managed superannuation funds or asked for a copy of the document. The document provides an overview of the Commissioner’s position on self managed superannuation funds. In particular, the Commissioner identifies conduct that may breach the rules and refers to conduct which may have the effect of “early release” of funds to related entities. According to the publication a linked/related trust was a characteristic used to select funds for audit because of the potential for a conflict of interest. While education to promote compliance is encouraged, it is clear from the publication the Commissioner will take action where contraventions are serious and the trustee does not rectify the breach.
  12. This publication is consistent with the policy and practice described in PS LA 2006/19 and was available for Mr and Dr K, and their accountants, to review at the time the Ashtonfield properties were sold and the loan to Mr K was made.
  13. The contraventions identified by the Commissioner are serious. They go to the heart of prudential regulation of superannuation funds as the provisions breached are designed to ensure the assets of a superannuation fund are preserved for retirement benefits. In the present case, the key issue of concern is that the assets of the Properties Unit Trust were used by Mr and Dr K for their own benefit. This would not have been a problem, but for the fact that the units in the Properties Unit Trust were the sole asset of the Fund and this has been the case since the fund was established in 1997. Mr K now accepts these were not “technical breaches”.
  14. The related party dealings in the Properties Unit Trust from 1999 to 2004, but especially in 2005, has affected the value of the Fund, which has not increased in value since this time. Moreover, there has been no income generated from the investment.
  15. The Fund has been exposed to greater risk because the investment in the Properties Unit Trust is not documented, there is no security and, for the reasons set out above, may not be recoverable.
  16. I accept that the Fund was not set up as a “sham” to improperly gain tax concessions, but the use of the funds and assets through the Properties Unit Trust from 1999 to 2005 provided a mechanism for the “early release” of benefits before retirement with no consideration of the effect on the Fund by the trustee or its directors.
  17. In my view, the nature and extent of the contraventions are serious and militate against issuing a notice of compliance.

ALL OTHER RELEVANT CIRCUMSTANCES

  1. PS LA 2006/19 identifies the following matters as relevant circumstances to consider when exercising the discretion to treat a non-complying fund as complying:
  2. I accept the circumstances leading to the sale of the Ashtonfield properties were difficult for the family and that Dr K may have had to sell the family home. I also accept that Mr K and Dr K may have been personally pursued by the National Australia Bank or Bank West if the Ashtonfield properties had not been sold to reduce the debt. The difficulty is that the assets of the Properties Unit Trust were used to secure loans to related parties, including the law firm. The sale of the Ashtonfield properties paid debts owed by Mr and Dr K.
  3. According to the accounts of the Properties Unit Trust the indebtedness of Mr K increased from $13,583 to $190,410 between 2004 and 2005 and loans from Mr K and his law firm totalling $324,012 were paid from the sale of the Ashtonfield properties. According to the financial statements for the Fund for 30 June 2005, the net assets increased by approximately $85,000 (from $95,082 to $181,271) after taking into account tax liabilities of $8,962, but this was solely attributable to the increase in the total assets of the Properties Unit Trust, which was the unsecured loan to Mr K.
  4. There has been no attempt by Mr K to repay the loan or pay interest on the loan since 2005.
  5. I accept that the applicant and Mr and Dr K, who were managing the applicant, had little skill and knowledge about the role of a trustee of a self managed superannuation fund. Mr K has been a lawyer in private practice for approximately 27 years. But this is not his area of practice and he gave evidence, which I accept, he did not understand the impact of the contraventions of the SIS Act on the Fund. Mr K took advice from accountants and says he followed this advice. Dr K had less understanding of how the Fund operated and the role and responsibilities of a trustee of a self managed superannuation fund.
  6. While this is a relevant consideration, this does not excuse the contraventions. The applicant operated the Fund since 1997 and Mr and Dr K were directors of the applicant from about 1995. The evidence is that neither took proactive steps to inform themselves of the duties of a trustee of a self managed superannuation fund or in relation to their duties as directors of the trustee company. Mr K gave evidence he signed the financial statements of the Properties Unit Trust and the Fund without reading or understanding them and relied on his accountant, but made no independent assessment.
  7. Mr and Dr K now acknowledge those duties and both have expressed regret and have sought to reassure the Tribunal and the Commissioner that non-compliance will be rectified and will not be repeated. I accept these acknowledgements and reassurances are genuine. However, this will not outweigh other factors, such as the seriousness of the contraventions, the compliance history of the Fund and any steps taken to rectify the contraventions.
  8. The Commissioner contends the Fund has a history of non-compliance because the Properties Unit Trust had been lending to various family related entities since at least 1999. There is no other evidence of non-compliance, although there is evidence of outstanding tax debts by Mr K, the law firm and the Family Trust, which may be relevant to the offer of an enforceable undertaking.
  9. In my view, the history of non-compliance by the Fund weighs against the favourable exercise of the discretion, but is not determinative in this case. The breaches are of a similar nature to the contraventions alleged in 2005 and are the result of Mr and Dr K using the Properties Unit Trust for the benefit of the family entities and failing to appreciate, or have regard to, the effect of those transactions on the investment of the Fund in the Properties Unit Trust.
  10. In the present case, one of the key factors in determining whether the Fund should be given a notice of compliance, or conversely whether the notice of non-compliance should be set aside, is the seriousness of the contraventions and the extent to which the trustee has rectified those contraventions or taken steps to ensure the contraventions will not arise again.
  11. I have already found the contraventions were serious. Prior to the issue of the notice of non-compliance the trustee offered an undertaking but the offer did not seek to rectify the contraventions and allowed Mr K to take the benefit of the breach without restoring the Fund to its full value as if the breaches had not occurred. Moreover, the offer did not take into account the interest of the other member of the fund, Dr K. This suggests that neither the applicant, nor its directors, appreciated the seriousness of the contraventions at the time of the offer, even though these matters were drawn to their attention by notice dated 12 November 2009.
  12. The applicant and Mr and Dr K have offered a new enforceable undertaking, which was made after the commencement of the hearing but before the resumed hearing and closing addresses. The undertaking was submitted to the Commissioner and the Tribunal by letter dated 21 October 2010 and seeks to address the contraventions of the Fund. It is contended the enforceable undertaking should be accepted as an alternative to the notice of non-compliance, which would be set aside.

SHOULD THE ENFORCEABLE UNDERTAKING BE ACCEPTED?

  1. The new enforceable undertaking was offered by the applicant and Mr and Dr K just before the resumed hearing and as the Commissioner did not have sufficient opportunity to respond, the parties were given leave to file supplementary written submissions in relation to the undertaking after closing submissions. Both parties took advantage of this opportunity and made detailed submissions addressing the terms of the proposed undertaking. In particular, the Commissioner referred to the guidelines set out in Practice Statement Law Administration (PS LA 2006/18) which outlines the factors that will be considered by the Commissioner in deciding whether to accept a written undertaking proposed by trustees to address contraventions of the SIS Act.
  2. It was accepted by the Commissioner the Tribunal’s powers extend to deciding, in an appropriate case, that the Commissioner should accept a written undertaking: Australian Securities and Investments Commission v Donald (2003) FCR 7; [2003] FCAFC 318 and Re XPMX and Commissioner of Taxation (2008) 73 ATR 925; [2008] AATA 981.
  3. Under paragraph 9 of PS LA 2006/18, it is noted that a notice of non-compliance will not be given to a self managed superannuation fund if the Commissioner has accepted an undertaking by the trustee to rectify a contravention, “provided the trustee is genuinely attempting to satisfy the terms of the undertaking”. An undertaking must contain, as a minimum, the essential terms described in paragraph 24, which include:
  4. There is further guidance at paragraph 19, which provides an undertaking will not be accepted if the contravention cannot be rectified, there are criminal consequences, the behaviour of the trustee indicates the trustee is unlikely to comply or the nature and the seriousness of the contravention indicates it would be inappropriate to accept an undertaking. The guide suggests that an example of a serious contravention where it would be inappropriate to accept an undertaking is where 100% of member contributions are immediately lent to members.
  5. The Commissioner submits the proposed undertaking is not acceptable and the main issues identified, together with the response on behalf of the applicant, follows.
  6. The Commissioner contends that, in the absence of loan documentation and other records, he cannot be satisfied that the amount recorded in paragraph 1.4 of the proposed enforceable undertaking of $190,411, being the amount recorded in the financial statements of the Properties Unit Trust as a loan to Mr K, is in fact correct. Even if this could be established, the Commissioner contends that the evidence suggests the applicant is unwilling and/or unable to rectify the relevant contraventions. At the time the enforceable undertaking was offered, Mr and Dr K did not have approval to borrow $100,000 and there is no evidence that such approval could be obtained. The enforceable undertaking does not seek to fully restore the Fund to the position if the contraventions had not occurred and there is no proposal to pay interest on commercial terms from 2005. The Commissioner says the amount required to restore the Fund would be $300,745 based on interest rates as set out in Division 7A of the ITAA, which is the Indicator Lending Rates–Bank variable housing loans interest rate last published by the Reserve Bank of Australia before the start of the year of income: s 109N(2).
  7. The Commissioner is not satisfied the applicant and/or Mr and Dr K will be able to comply with the enforceable undertaking in the event of financial hardship and says, in these circumstances, an undertaking should not be accepted. There is no information about the value of the proposed security to enable the Commissioner to evaluate the appropriateness of the security being offered by Dr K. There is also evidence the taxation compliance history of the applicant, the Family Trust, Mr K and his law firm “has been poor for many years”. In particular, the Commissioner refers to tax liabilities for related entities (the Family Trust, Mr K and his law firm), which total approximately $108,000 as at 14 October 2010. While there is no evidence these liabilities were in default at the time of the statement, which the Commissioner concedes, he nonetheless contends these liabilities are relevant to consideration of whether the family, and in particular Mr K, will be able to comply with the terms of the undertaking and repay interest and amounts owing to the Properties Unit Trust.
  8. The Commissioner seeks to rely on letters dated 8 January 2008, 11 October 2008 and 8 November 2008, which evidence defaults in complying with arrangements for payments of tax liabilities already outstanding. These liabilities were for the Fund ($3,804.20), Mr K ($5,248.15), and the law firm ($21,311.08). The Commissioner also seeks to rely on unpaid tax debts as evidence by notices dated 6 June 2008 for the Family Trust ($4,642.20) and 20 May 2010 for Mr K ($7,481.74).
  9. The Commissioner submits the nature and seriousness of the contraventions make it inappropriate to accept the enforceable undertaking as they relate to the whole of the assets of the fund and involve a complete “subversion of the legislative scheme”. Moreover, there is no training course currently approved by the ATO, but even if there were such a course, “the proposed undertaking does not carry great weight in light of the longstanding failure of both [Mr K] and [Dr K] to inform themselves adequately of their responsibilities as directors of the corporate trustee, prior to the hearing before the Tribunal”.
  10. In response, the applicant submits that the objects of the SIS Act to promote prudent management of self managed superannuation funds contemplates taking into account the best interests of the members of the Fund. It would not be in the best interests of members to impose a tax liability of $93,000, which would reduce possible retirement benefits. The acceptance of the enforceable undertaking is therefore the correct and preferable decision.
  11. The applicant does not agree that the loan to Mr K should be valued at $300,000 and submits Mr K should be treated as an arm’s length debtor in default. It is therefore appropriate for the Properties Unit Trust (and thereby the Fund) to make a “realistic” assessments about what can be recovered in the circumstances. In this case, recovery of the principal, with interest accruing on only part of the debt from the date of the undertaking, is said to be “prudent”. In any event, a more appropriate interest rate to apply is the interest rate offered of 7.5%, which is comparable with the five-year fixed interest rate offered by the National Australia Bank.
  12. It is also submitted for the applicant that the financial position of Mr K has improved and evidence from the Commissioner about defaults relate to an earlier period when Mr K concedes he was in difficult financial circumstances. According to the evidence of Mr K, fees generated from his legal practice have more than doubled since 2007 and profitability has improved. Moreover, it is submitted there is no evidence Mr K and the related entities have a poor compliance history and the ATO must bear some responsibility for failing to adequately educate trustees of self managed superannuation funds on their role and responsibilities. The Tribunal should take into account that Mr and Dr K were never advised about the responsibilities of trustees of a self managed superannuation fund by their advisers or the ATO. Dr K otherwise has a good compliance history.
  13. I agree with the Commissioner’s submission that the proposed enforceable undertaking should not be accepted as an alternative to the notice of non-compliance.
  14. One of the key principles that underlie the exercise of discretion to accept an enforceable undertaking is that action should be taken to rectify the contraventions and to ensure breaches are not repeated. In the present case, the proposed undertaking does not seek to rectify the contraventions or put the Fund in the position it should have been in but for the contraventions. The Commissioner says this means restoring the investment in the Properties Unit Trust to $300,000 to take into account an investment based on “arm’s length” commercial terms. The submission for the applicant misconceives the test of how this should be assessed as it is argued the Fund should bear the loss of the poor investment. As outlined earlier, this illustrates the policy behind the regulatory provisions that are designed to promote prudent management of retirement savings. If the Fund had not invested in the Properties Unit Trust, but in an arm’s length secure arrangement, it is likely the investment would have increased over the last five years. There is no evidence, other than the Commissioner’s submission, of what the value should be. However, the undertaking proposed by the applicant does not give credit for any increase and therefore does not properly address the contraventions or recognise the problems created by the breaches.
  15. It is relevant there is no evidence to support future compliance with the undertaking. There is no evidence funds will be advanced to repay the first lump sum, nor is there evidence about the future capacity of Mr K to make payments. There is evidence the financial position and profitability of the law firm has improved since 2007 but given the current tax liabilities of the family entities and the previous history of payment default, it is not unreasonable to question the financial viability of the proposed undertakings. The applicant and Mr and Dr K argue these undertakings are reasonable and should be accepted as an alternative to the notice of non-compliance. However, I am not satisfied the proposal is viable based on the information provided.
  16. I agree with the Commissioner that the nature and extent of the contraventions are serious because they impact all of the assets of the Fund. The related party lending was through the Properties Unit Trust, rather than the Fund, and as such the impact was indirect. The impact was nonetheless serious and, while I do not agree acceptance of an enforceable undertaking would be “inappropriate” in such a case, undertakings for rectification and assurances of future compliance should meet a sufficiently high standard to negate the breaches.
  17. The submission by the applicant that the Tribunal should now take into account the best interests of the members as a primary consideration misconceives the legislative scheme and, in my view, would be inconsistent with the objects and provisions of the legislation. Tax concessions are allowed to self managed superannuation funds provided they comply with the regulatory provisions. If those regulatory provisions are contravened, it would undermine the legislative scheme if a self managed superannuation fund was allowed to be treated as complying simply because it would be in the best interests of members not to withdraw tax concessions and/or impose tax liability. This approach gives disproportionate weight to the tax consequences of issuing a notice of non-compliance, regardless of the seriousness of the contraventions and the attitude of the trustee to compliance.
  18. I accept Mr and Dr K had little experience in superannuation and now appreciate the seriousness of the contraventions. Notwithstanding this, these submissions fail to recognise the applicant and Mr and Dr K, as directors of the applicant, rather than their advisers and the ATO, have the primary responsibility in complying with the legislation. This submission provides little comfort to a decision-maker about future compliance.
  19. An enforceable undertaking was accepted in Re XPMX and Commissioner of Taxation (2008) 73 ATR 925; [2008] AATA 981, but in that case the contraventions were not as serious as those in the present case and the undertaking would have rectified the breach identified.

CONCLUSIONS

  1. I agree with the observations of Senior Member Carstairs in Re JNVQ and Commissioner of Taxation (2009) 74 ATR 730; [2009] AATA 522 at [41], that in exercising the discretion in s 42A(5):

... Any exercise of discretion must have regard to considerations of unfairness in a particular case, but must be applied in a manner consistent with the objects of the relevant Act. It is important to have regard to whether, by exercising the discretion in a particular case, the decision-maker will be achieving or frustrating those objects.

  1. In the circumstances of this case and weighing up all the factors, I find that the proposed enforceable undertaking should not be accepted as an alternative to the notice of non-compliance issued by the Commissioner.
  2. I am satisfied the contraventions of the applicant are serious and the impact on the Fund has been significant. As in Re JNVQ and Commissioner of Taxation (2009) 74 ATR 730; [2009] AATA 522, there has been no attempt to rectify the contraventions in the five years following the sale of the Ashtonfield properties. The new undertakings offered do not go far enough to address concerns of non-compliance or future compliance. In my view it would be inconsistent with the objects of the SIS Act to issue a notice of compliance in these circumstances. I find that the notice of non-compliance should not be set aside, nor should a notice of compliance be issued under s 42A(5) of the SIS Act.
  3. Accordingly, I affirm the decision of the Commissioner.

I certify that the 110 preceding paragraphs are a true copy of the reasons for the decision herein of Ms J L Redfern, Senior Member

Signed: ............[sgd]....................................................................

Associate

Dates of Hearing 15 and 22 October 2010

Date of Decision 10 January 2011

Appearance for the Applicant Mr J Curry, Incentive Business Accountants

Appearance for the Respondent Ms J Gleeson of counsel instructed by

Ms M Huayllasco of ATO Legal Services

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