CASE 47/94

BJ McMahon DP

Administrative Appeals Tribunal

Decision date: 23 August 1994

BJ McMahon (Deputy President)

This is an application to review a decision of the delegate of the respondent made pursuant to s 13 of the Occupational Superannuation Standards Act 1987 (as it was then known) (``the OSS Act''). By virtue of s 5(2)(d)(ii) of the OSS Act, the former s 121C(5) of the Income Tax Assessment Act 1936 (``the ITA Act'') applies to limit the permissible level of in-house assets of superannuation funds for the 1989/90 year of income to the cost of the in-house assets of the fund as at 11 March 1985, or 10 per cent of the cost of all assets of the fund, whichever is the greater. In the financial year 1989/90 the cost of in-house assets of the applicant fund exceeded 10 per cent of the cost of all assets of the fund and consequently the fund failed to satisfy the requirements of the former s 121C(5) of the ITA Act and of regulation 16A(17)(b) made under the OSS Act. The applicant therefore

ATC 419

sought to have the respondent certify that it would be reasonable for the fund to be treated as if it had satisfied the Superannuation Fund conditions because of special circumstances, as provided in s 13 of the OSS Act.

2. There is provision in s 121C(5) which allows the respondent to disregard the failure to comply with that section where he is satisfied that the Trustee of the fund made a genuine and bona fide attempt to ensure that the in-house assets of the fund did not exceed at any time during the year of income, the level so specified, or that the failure was by reason of a temporary delay in investment. No attempt was made in the present application to argue that it would be reasonable in all the circumstances to resort to either of these exemptions from the general required formula.

3. In the relevant year, the Trustee of the fund was the employing company (``Group''), as it had been since the Fund was established on 25 June 1982. On 27 June 1991, after the relevant year, the identity of the Trustee was changed to the present applicant.

4. In February 1990, an associated company (``Corporation'') found that it was able to secure a significant financial advantage in a contract that it had with a New South Wales Government department, if it prepaid a manufacturing company in the United States. Corporation approached Westpac for a financial facility. The evidence before me was that the company was well able to obtain this accommodation from the bank on an arm's length basis. A rate of interest of between 17 and 18 per cent per annum was quoted. The proprietors of Group and Corporation decided that as a short term facility was needed, and as a substantial profit could be made from the loan, it was more advantageous to have the profit made by the fund rather than by Westpac.

5. At all times during the relevant year there were only 3 members of the fund namely, the husband and wife who were the substantial proprietors of Group and Corporation and a third person who was the company's secretary. It had been the practice of the fund to place the fund's moneys on deposit on a regular basis with financial institutions in order to obtain as attractive a return as possible. When the opportunity to lend to Corporation arose, the company secretary was instructed to enquire of a number of financial institutions as to the rate of return which the Fund could obtain for moneys placed on deposit. The proposed loan of $215,000 to Corporation on an unsecured basis carried with it an obligation to pay $15,000 in interest at the end of the term of the loan in eight weeks. This represented an annualised interest rate of 41.86 per cent per annum. The company secretary, not surprisingly, reported that it was not possible to obtain a comparable return with any financial institution.

6. Because an investment of this type was different from the normal course of investments made by the fund, a meeting was held on 2 February 1990 of all 3 members. It was agreed that if any of the members of the fund was opposed to the making of the investment, the Trustee would not authorise it. In the event, the making of the investment on the terms proposed was unanimously approved by all members of the fund and the loan was made.

7. In his affidavit, the husband said that at the time he was aware of the terminology ``in- house'' assets but did not correctly understand its technical meaning. He said in his affidavit that he did not realise that the ``in-house'' assets rules were applicable to loans made to an associated company even when the dealings were at arm's length and a very favourable commercial rate was obtained. In his evidence before me, it became clear that he had no understanding of the meaning of ``in-house'' assets. It emerged that his understanding was that all assets of a fund were in-house assets. He gave evidence that he had not sought advice on the meaning of this term prior to the transaction in question.

8. The loan was made and the principal and interest were repaid eight weeks later. The cost of the in-house assets of the fund as at 11 March 1985 was $49,398. This comprised a loan of $7,600 to Group, together with shares to the value of $41,798 in Corporation. During the relevant year, the cost of total assets was $365,782 taking into account the loan to Corporation. The cost of in-house assets was $215,000 (the loan to Corporation) representing 58.78 per cent of the cost of total assets.

9. The taxable income of the fund for the relevant year was $74,676 upon which gross tax of $35,844.48 was levied. Because the respondent has declined to find that it would be reasonable for the fund to be treated as if it had satisfied the Superannuation Fund conditions in the relevant year, an additional amount of tax of

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$34,153.70 has been assessed. The company secretary retired from the fund on 12 or 13 June 1991 (after the relevant year) and the benefits payable to her were not calculated on the basis that the Fund would have to pay additional tax. Consequently the burden of the additional tax would be borne by 2, rather than 3 members, if the respondent's decision is to stand.

10. The husband gave evidence that he agreed to the fund making the loan in order to assist the long term retirement interests of the fund's members. In his view, the fund would have been prejudiced by its failure to take up an excellent, safe investment opportunity. If the fund is treated as non-complying, the tax effect of the breach would disadvantage both the husband and the wife's long term retirement interests. The husband is aged 53 and, in his belief, the fund does not have sufficient time to recover from the financial disadvantage of non- compliance prior to his retirement.

11. The directors of the applicant undertook to continue to ensure on behalf of that company that no such investment would be made in the future and to ensure that the fund complies with all the superannuation requirements.

12. The meaning of ``special circumstances'' as found in s 13 of the OSS Act was examined at length in Case Z27,
92 ATC 255. On appeal to the Federal Court under the name of
Tefonu Pty Ltd v Insurance and Superannuation Commissioner 93 ATC 4727, the reasons for decision of the Tribunal were not distinguished or made the subject of adverse comment. It may be taken therefore that the observations made in that case still have application. They were followed in Case 17/94,
94 ATC 198 and in Case 33/94,
94 ATC 306. Although it is important to remember that broad discretions ``should not by the gradual deposition of judicial decisions become fossilised into rigidity'' (
Minister for Community Services and Health and Anor v Chee Keong Thoo (1988) 78 ALR 307 at 324), nevertheless the types of circumstances that have been considered in these cases give an indication of what should be regarded as ``something unusual or different to take the matter out of the ordinary course'' (Chee Keon Thoo at 324). The applicant relied upon 6 circumstances which it submitted were special.

13. Firstly it was said that the nature of the breach was insignificant. The loan was only for a very short term (that is only 2 months) and therefore (it was said) the breach was only of a short term nature. In addition, the loan was not of a recurrent nature and was repaid on expiration of the term of the loan. The breach was also remedied before the Trustee became aware that a breach had occurred. This awareness arose only when the auditor pointed out the breach when he came to give his statutory certificate. This is in contrast (it was said) to the facts in Tefonu where the breach continued during 2 financial years and where the time taken to rectify the breach was almost one year. It was also in contra distinction to the facts in Case 17/94. It seems to me, however, that a breach of the in-house assets rules involving the great majority of the cost of total assets in the relevant year (58.78 per cent) can- not be regarded as insignificant. The amount of interest was significant. The amount of principal was significant, having regard to the size of the fund. Most of the assets of the fund were committed to the investment. In my view, it is not possible to view this breach as insignificant.

14. The second circumstance relied upon was the fact that all members of the Fund knew of and approved of the loan. If the object of the investment safeguards were to be regarded as the protection of the revenue of funds (it was said), then members' rights would not be served by treating the fund as non-complying. In Case 33/94 this Tribunal held, for reasons there given, that the fact that the interests of the beneficiaries were not at risk, was not in itself a special circumstance that was ``unusual, uncommon, exceptional and abnormal''. It must be taken that breaches of prudential requirements in superannuation funds cannot be cured merely by the consent of the members.

15. The third circumstance alleged to be special was that the loan was made in order to assist the long term retirement interests of the fund's members and that the fund would have been prejudiced by its failure to take up an excellent safe investment opportunity which was made in good faith to maximise the investment returns of the fund. Furthermore, it was said if the fund is treated as non- complying, the tax effect would disadvantage those long term retirement interests of the members. As to this submission, I would point out (as was pointed out in Case Z27) that adverse tax consequences will occur after the relevant period whereas s 13 of the OSS Act

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requires that the special circumstances are required to exist during the year of income. The applicant submitted that rewriting the accounts of the fund with retrospective effect would, in effect, cause this deemed adverse effect to have been in existence during the relevant year. In my view, the language of s 13 is not capable of sustaining such an interpretation. Furthermore, as was pointed out in Case Z27 (paragraph 37) circumstances of this nature cannot be regarded as special. Adverse fiscal consequences are considerations that could be raised on every occasion when the Commissioner is asked to give a notice under s 13.

16. The fourth circumstance is that at the time of making the loan, the Trustee misunderstood the nature of the standard. I can only repeat what has been said in all of the cases decided so far namely, that ignorance can- not be regarded as a special circumstance. The in-house investment limitation (unlike the relevant regulation in Case Z27) had been in effect for some 4 or 5 years prior to the relevant year. The trustee of any fund has a duty to inform itself of these statutory requirements. There is a ruling that has been published by the Commissioner of Taxation which is readily available to members of the public. Furthermore, there are instructions which are issued with each return form each year. The Trustee also had the benefit of advice from its accountant if it wished to seek it. A failure by the Trustee to inform itself of its obligations in these circumstances cannot be regarded as in any way special.

17. The fifth circumstance put forward was that the Trustees had undertaken to prevent any such investments being made in the future and had taken all steps necessary to ensure that the fund complied with the regulations. As it is obliged to observe the law like all other trustees of all other funds, I cannot see how this can be regarded as in any way a special circumstance.

18. Sixthly, the Trustee pointed to changes that have been made in the law since the relevant year and contrasted the harsh consequences that would befall the fund under the previous arrangements, compared with the more benign approach of recent legislation. On and from 1 July 1994 the OSS Act was retitled Superannuation Entities (Taxation) Act 1987 and many of its regulatory provisions were repealed. In general, it was replaced by the Superannuation Industry (Supervision) Act 1993. The thrust of that Act is to substitute penalties for trustees rather than to impose higher taxation consequences on members if breaches of the relevant investment requirements occur. I was given by the applicant a copy of the Minister's statement of 21 October 1992 dealing with these changes, and by the respondent a copy of new guidelines adopted in July 1994 for the exercise of the ``special circumstances discretion''.

19. I am unable to see how changes in the legislative structure can assist in determining whether what happened in the relevant year should be regarded as special circumstances. The new legislative scheme simply indicates a change of policy. In the absence of any specific provision in the new legislation giving retrospective effect to this policy, the legislation in place in the relevant year will continue to be binding for that year. The applicant pointed to the enactment of s 12(3A) of the OSS Act which was effected by Act Number 7 of 1993. It provides that (in effect) a fund cannot lose its tax concessions in a year of income if the Trustee rectifies any contravention of the law within 30 days of becoming aware of the contravention. It was submitted by the applicant that this should provide ``positive guidance to the respondent'' as to how the respondent's discretion, as it existed before the changes, should be applied. In the present case, of course, the breach was rectified even before the Trustee became aware of it. It was submitted that in those circumstances, had the breach occurred after 1 July 1993, the respondent would be bound to exercise its discretion favourably. In fact, of course, the breach presently under consideration occurred more than 3 years earlier. I am unable to see how, in the absence of specific provisions in s 12(3A) displacing the normal rule that legislation speaks from the date of its enactment, the respondent could justify any reliance on the concepts reflected by sub-section 12(3A) in dealing with the present application.

20. I have concluded that no special circumstances have been shown to have existed in relation to the fund during the year of

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income, and accordingly it would not be reasonable for the fund to be treated as if it had satisfied the Superannuation Fund conditions. The decision under review is therefore affirmed.

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