The Commissioner of Taxation (Commissioner) can disqualify a trustee or a director of a corporate trustee (DOACT) of a self-managed superannuation fund (SMSF) under Subdivision 3A – Disqualification by the Commissioner of Taxation) of Part 15 of the Superannuation Industry (Supervision) Act 1993 (SIS Act). While Subdivision 3A deals with disqualification by the Commissioner, Subdivision 3B deals with disqualification by the Federal Court.

When will the Commissioner disqualify a trustee or a DOACT of a SMSF?

Every SMSF is a regulated superannuation fund (RSF) under section 19 of the SIS Act.

Disqualification of a SMSF member occurs automatically when a member of a SMSF is made bankrupt. The Commissioner can also disqualify a member under Division 3A for other behaviour such as:

• repeated SIS Act breaches;
• significant failures to comply with RSF operating standards in the SIS Act and SIS Regulations; and
• egregious lending to members, misuse of fund assets or persistent reporting failures.

It is an offence for a disqualified person to be a trustee or a DOACT of a SMSF: section 126K of the SIS Act. Further, use of the limited exceptions to the requirement that all members of a SMSF must be trustees or DOACTs of the SMSF is effectively blocked by subsection 17A(10) of the SIS Act. That provision prevents a legal personal representative of a disqualified person from acting as a trustee or DOACT of a fund and the fund continuing as a SMSF under section 17A.

Practical consequences

There are serious practical consequences when a participant in a SMSF is disqualified under Division 3 of Part 15. These consequences are not always understood when legislation in Division 3 or ATO guidance on disqualification by the Commissioner in:

Practice Statement Law Administration PS LA 2006/17 – Self-managed superannuation funds: disqualification of individuals to prohibit them from acting as a trustee of a self-managed superannuation fund
https://tinyurl.com/2brjcwyh

is considered.

They can be a tale of woe for the SMSF. A disqualification will usually mean:

• the disqualified person must resign or be removed as a trustee or DOACT forthwith before charges under the section 126K offence are laid; and
• the remaining members of the SMSF must act promptly to maintain SMSF status.

That said, preserved benefits in the fund are not generally jeopardised unless the behaviour also leads to:

• penalties or increased tax on the fund; or
• the fund being made non-complying.

However, the benefits of disqualified persons generally cannot continue to be held in the fund if it is to continue as a SMSF. That is, a RSF cannot persist as a SMSF after expiry of the grace period while a disqualified person remains as a member of the superannuation fund.

Superannuation fund poised to become non-complying

Disqualification of a trustee or a DOACT can accompany action by the Commissioner to make a SMSF non-complying. When that may happen, and the severe tax consequences of it happening, should be briefly explained.

The Commissioner can consider withdrawing complying status for any contravention by the trustee(s) or DOACT(s) of the SIS Act, the SIS Regulations and other legislation referred to in section 38A of the SIS Act. The Commissioner, as the regulator of SMSFs, ultimately has a duty, in the form of a discretion under paragraph 42A(5)(b), to refrain from making a SMSF non-complying after considering:

(i) the taxation consequences that would 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;
(ii) the seriousness of the contravention or contraventions; and
(iii) all other relevant circumstances.

In other words, only an exercise of discretion by the Commissioner will prevent the SMSF from becoming a non-complying fund under section 42A where the behaviour described above is identified.

Catastrophic taxation, severely depleting all member account balances in a RSF, can follow when a SMSF that was previously a complying fund is made non-complying under section 42A. Effectively, all assets of the RSF are taxed based on their market value at 45% under item 2 in the table in section 395-120 and section 395-125 of the Income Tax Assessment Act 1997.

Effective ejection from the SMSFs system

As stated, disqualification of a trustee or DOACT does not just disqualify the person from acting as a trustee or DOACT.

The practical effect of a disqualification of a trustee or DOACT extends to their participation as a member of any SMSF, given that SMSFs are RSFs with the design feature that all members of the RSF act as the trustees or DOACTs of the RSF in which they are members. A disqualified person is therefore effectively ejected from the SMSF environment with:

• the disqualified person losing the privilege of acting as a trustee or DOACT of a SMSF and of being a member of a SMSF; and
• a SMSF in which the disqualified person is a member being unable to continue as a SMSF after the six-month grace period provided by subsection 17A(4) of the SIS Act.

This grace period allows a SMSF with a disqualified trustee, DOACT or member six months to reorganise by ejecting the disqualified person so that SMSF status on the Australian Business Register (ABR) can be retained. The grace period does not apply to the section 126K offence. Section 126K requires a disqualified person to cease acting as a trustee or DOACT of a fund immediately upon becoming disqualified.

Woe on the Australian Business Register

If a SMSF with a disqualified person involved in any capacity cannot reorganise in time, the fund will lose SMSF status after any grace period allowed. On loss of SMSF status, the fund is no longer regulated by the Commissioner and the ATO will update the Australian Business Register (ABR) accordingly. A RSF continues to be regulated and subject to the SIS Act however.

Effectively, this leaves the fund with no SMSF status with the ATO to resolve its regulatory problems. The ABR on ABN/Super Fund Lookup will show the fund as a RSF regulated by APRA (by default). This ABR outcome reflects an administrative default, not that the fund has lawfully become a small APRA fund. This consequence brings home that operating as a SMSF is a privilege which members who seek to control their own superannuation will seek to preserve.

After the grace period, superannuation benefits of a disqualified person can only be held in an APRA-regulated fund.

Avoiding loss of SMSF status

Plainly, to avoid loss of SMSF status, the trustees and DOACTs of a SMSF need to act promptly to eject a trustee, DOACT or member who is about to be, or has just been, disqualified. To achieve this in time, the trustee or DOACT must resign, be removed (or die), and their member account must be wholly transferred or rolled over to an APRA-regulated product so that their membership of the SMSF terminates within the grace period.

Trust deed failsafe

If these actions cannot be taken in time and disqualification of one or more trustees, DOACTs or members cannot be forestalled with the Commissioner, then, as a last resort, the trust deed of the fund may assist if it contains provisions allowing the fund to convert to a small APRA fund.

Such provisions are included in quality SMSF trust deeds, such as those supplied by The Tax Objection. They allow the members of the fund to appoint an approved trustee so the fund can preserve its complying status if it becomes regulated by APRA in these circumstances. An approved trustee is:

• expensive, with the cost borne by the members; and
• independent of the members, including in relation to investment decisions concerning member benefits.

In practice, this last-resort solution is a short-term, transitional or emergency measure to prevent immediate roll-out of all benefits to other superannuation vehicles and a forced wind-up.

Ideally, a person under threat of disqualification should exit the fund entirely with their benefits before SMSF status is lost. If that is not possible, and they remain in the fund when disqualified, then conversion to a small APRA fund for a short period during or following any available grace period may provide redundancy. This allows the disqualified person to remain a member while any reversal of the disqualification and reinstatement as a SMSF in compliance with the SIS Act is pursued.