Edited version of your private ruling

Authorisation Number: 1012608950334

Ruling

Subject: Superannuation lump sum benefits

Question

Is the Commissioner satisfied that it would be unreasonable to include in your client's assessable income superannuation benefits that were released in breach of legislative requirements?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 2013.

The scheme commences on:

1 July 2012.

Relevant facts and circumstances

Your client has attained their preservation age.

Your client was the sole director of the corporate trustee (the Trustee) for the superannuation fund (the Fund).

When the Fund was established, the Fund elected to become a regulated superannuation fund.

Your client was the sole member of the Fund, which was a self-managed superannuation fund (SMSF).

Your client lodged a voluntary disclosure letter in relation to the early access of benefits from the Fund.

The Fund representative provided further information including Fund/member bank account statements and transaction details.

An audit of the Fund was subsequently conducted and the Fund was found to have contravened section 34 and section 62 of the Superannuation Industry (Supervision) Act 1993 (SISA).

You requested the Commissioner indicate whether the amount of early accessed benefits will be excluded from your client's assessable income for the 2012-13 income year under subsection 304-10(4) of the ITAA 1997 prior to lodging your client's 2012-13 income tax return.

You included your client's statement outlining the summary of the circumstances that led to the early access of benefits as follows:

• the monies withdrawn from the Fund were intended as a loan to be repaid with appropriate interest.

• the monies withdrawn were transferred to an internet romance scammer.

• the loans were meant to be short-term loans only as your client expected the payment of funds to promptly facilitate the ability of the person to return to an overseas country, where their funds would become available for repayment.

• whilst your client had sole effective control of the Fund as sole director of the corporate trustee (the Trustee), your client never received the use of, or benefit from, the money withdrawn from the Fund as the money was all sent to the scam artist.

• the scammer provided a number of urgent reasons why they needed additional money sent. Your client had already provided personal cash funds and additional approved credit card funds and had no access to other personal funds

• your client had taken steps to report the matter to the police

• your client does not have any likely prospects of the money being returned

You also made reference to a number of decisions on similar issues.

You advise your client is unable to repay the Fund any monies which have been withdrawn inappropriately.

You stated your client has taken remedial action under the enforceable undertaking to rectify the contraventions including winding up the Fund.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 304-10(1)

Income Tax Assessment Act 1997 Subsection 304-10(4)

Superannuation Industry (Supervision) Act 1993 Section 31

Superannuation Industry (Supervision) Act 1993 Section 34

Superannuation Industry (Supervision) Act 1993 Section 62

Superannuation Industry (Supervision) Regulations 1994 Subregulation 6.01(7)

Superannuation Industry (Supervision) Regulations 1994 Subregulation 6.17(2)

Superannuation Industry (Supervision) Regulations 1994 Subregulation 6.18(1)

Superannuation Industry (Supervision) Regulations 1994 Subregulation 6.19(1)

Superannuation Industry (Supervision) Regulations 1994 Schedule 1

Reasons for decision

The Superannuation Industry (Supervision) Act 1993 (SISA) does not prescribe what a superannuation fund can and cannot invest in.

They do, however, restrict some investment practices of superannuation funds. The investment restrictions in the SISA and SISR aim to protect fund members by ensuring fund assets are not overly exposed to undue risk. In addition, they aim to ensure that funds make investment decisions with the primary purpose of generating retirement income benefits for members rather than providing current day support.

Paragraph 65(1)(a) of the SISA prohibits the trustees of a regulated superannuation fund from lending money to a member or a relative of a member of the fund.

Paragraph 65(1)(b) of the SISA prohibits the trustees of a regulated superannuation fund from giving any other financial assistance using the resources of the fund to a member or a relative of a member of the fund.

Contravention - Early Access

Prior to a benefit being paid to a member certain conditions must be met. Section 31 of the SISA states that the SISR may prescribe operating standards.

The payment standards specified in the Superannuation Industry (Supervision) Regulations 1994 (SISR) are operating standards for the purposes of section 31 of the SISA and are required to be complied with under section 34 of the SISA.

Section 34 of the SISA provides that a trustee of a regulated superannuation fund must ensure the prescribed standards regarding the payment of benefits are complied with at all times.

Subregulation 6.17(2) of the SISR provides rules on when a member's benefit may be paid from a regulated superannuation fund. These rules ensure that a member's benefits are only paid in accordance with the payment and preservation standards and the superannuation fund rules. This subregulation states that a member's benefit may be paid :

(i) by being cashed in accordance with Division 6.3; or

(ii)  by being rolled over or transferred in accordance with Division 6.4, 6.5 or 6.7; or

(ii) by being allotted under Division 6.7; and

must not be paid in that way except when, and to the extent that, the fund is required or permitted under this Part to pay them.

Subregulation 6.18(1) and subregulation 6.19(1) of Division 6.3 of the SISR prescribe that a member's preserved benefits and restricted non-preserved benefits in a regulated superannuation fund may be cashed on or after the satisfaction of a condition of release. The conditions of release are found in Schedule 1 of the SISR.

Schedule 1 of the SISR sets out the conditions of release for payment of benefits to a member. These include but are not limited to the following. The member must have:

(i) attained the age of 65;

(ii) retired from gainful employment;

(iii) have compassionate grounds for release;

(iv) permanent incapacity; severe financial hardship or terminal illness or injury; or

(v) attained preservation age where the amount paid is paid as a transition to retirement income stream, a non-commutable allocated annuity, non-commutable allocated pension, a non-commutable annuity or a non-commutable pension. For a person born before 1 July 1960, preservation age is 55 years.

Applying the law to the facts

The Commissioner notified the Trustee to advise the member of their requirement to report the benefits plus any additional benefits received without meeting a condition of release, as assessable income in their personal income tax return for the 2012-13 year of income. This was in accordance with section 304-10 of the Income Tax Assessment Act 1997 (ITAA 1997).

Your client operated as a consultant contractor until the end of the 2011-12 income year and retired at that time.

From the information provided by the Fund following the voluntary disclosure, it can be seen that the Fund accepted employer contributions on behalf of the member during the period when the monies were withdrawn from the Fund. The member also received regular fortnightly income payments from the employer.

It is therefore evident that at the time the fund monies were released to the member, the Trustee had knowledge of the member's employment and that the member had not retired at that time. The Trustee also had known the member had not terminated from gainful employment at any time during the same period. Therefore, clearly, the Trustee was fully aware the condition of release under the SISR had not been met to allow the monies to be released to the member.

By allowing preserved benefits to be cashed without having satisfied a condition of release, the Trustee has failed to comply with regulation 6.17 of the SISR which is a prescribed operating standard for the purposes of section 31 of the SISA.

Consequently, the Fund has contravened section 34 of the SISA.

Seriousness of the section 34 contravention

Early access to member benefits is considered to be one of the most serious contraventions of the SISA. The purpose behind superannuation is to provide benefits for members in their retirement. By paying the member's superannuation benefits to the member without meeting a condition of release contravenes the sole purpose of superannuation.

The SMSF trustee needs to at all times:

• act honestly in all matters concerning the fund

• keep the money and assets of the fund separate from other money and assets (for example, personal assets)

• cannot access or allow others to access funds early .

Schedule 1 of the SISR sets out the conditions of release for payment of benefits to a member. Under the Payment Standards contained in Part 6 of the SISR, subregulation 6.01(7) considers the circumstances of when the 'retirement of a person' has occurred for the purposes of Schedule 1.

For a trustee to consider that the retirement of a member is taken to have occurred (where the member has reached their preservation age that is less than 60), the trustee has to be satisfied that an arrangement under which the member was gainfully employed has come to an end and the trustee is reasonably satisfied that the member intends never to again become gainfully employed, either on a full-time or a part-time basis.

In your client's case, when the monies were withdrawn from the Fund account, the Trustee could not have been satisfied the member had terminated from gainful employment as the Trustee had accepted employer contributions in respect of the member prior to, during and after the period the fund monies were withdrawn. The withdrawn monies also represented almost the entire member account balance in the Fund.

Whilst it is acknowledged that the member had reached preservation age and had retired for a short period, it is also clear the Trustee had full knowledge that the member again became an employee after this time.

You have stated your client always had sole effective control of the Fund as the sole director of the Fund's corporate trustee and was also the sole member of the Fund.

Therefore it is concluded that the Trustee had full knowledge that the benefits paid to the member at that time did not meet the condition of release as prescribed by section 34 of the SISA to allow the release of the benefits to the member.

Contravention - Sole Purpose

Section 62 of the SISA outlines the sole purpose test. The object of the sole purpose test is to ensure that regulated superannuation funds are maintained for the purpose of providing benefits to members upon their retirement, or their dependants in the case of a member's death before retirement. The trustees of an SMSF must comply with the sole purpose test to be eligible for tax concessions available to a complying superannuation fund.

Paragraph 6 of Self-managed superannuation funds ruling 2008/2 (SMSFR 2008/2) states that a trustee must maintain the SMSF in a manner that complies with the sole purpose test at all times, including investing, employing and using fund assets. The SMSF trustee is therefore required to invest, employ and use fund money in accordance with the sole purpose test.

Applying the law to the facts

From the information provided, it has been stated that the monies had been intended to be a loan to the member who then used the accessed funds to send to a third party. The unfortunate nature of these circumstances is noted.

However, the total amount of the withdrawals represented almost the entire member account balance at the time including employer contributions which were accepted by the Fund during this period. Therefore the circumstances clearly show that the payment of benefits were not made for the benefit of the member in retirement.

Such actions clearly display a lack of due diligence on the Trustee's part to adhere to section 62 of the SISA and as such, the actions taken by the Trustee have contravened that section.

Seriousness of the section 62 contravention

The Commissioner considers that a contravention of the sole purpose test to be of a serious nature as the intent of the legislation is to ensure that the retirement income objective of the SMSF is paramount. The sole purpose test and the associated standards prohibit the use of concessionally taxed superannuation savings for purposes such as providing pre-retirement benefits.

The Commissioner has consistently provided guidance to SMSF trustees by publishing SMSF information guides, rulings and determinations to highlight the importance of the SMSF trustee's role and responsibilities in ensuring compliance with superannuation law in order to receive concessional tax treatment on SMSF investment earnings.

Compliance with the payment standards and the sole purpose test ensure money in the SMSF is paid to members only when they are legally allowed to access it.

Payments in breach of legislative requirements

Subsection 304-10(1) of the ITAA 1997 includes the amount of superannuation benefits paid in breach of legislative requirements in the recipient's assessable income for the income year. The tax treatment set out in section 304-10 overrides the concessional tax treatment that would otherwise apply to the benefits if not for the breach.

Subsection 304-10(4) however provides that an amount is not to be included in the recipient's assessable income to the extent that the Commissioner is satisfied that it is unreasonable that it be included having regard to the nature of the fund and any other matters considered relevant.

In your request for the Commissioner to apply subsection 304-10(4) to your client's circumstances, you also made reference to a number of similar decisions on the same issue.

You consider your client's circumstances can be distinguished from the circumstances in those decisions as your client never received the use of, or benefit from, the money withdrawn from the Fund because your client sent all the withdrawn amounts to the scam artist. That, as the sole fund member, no other parties were affected by your client's actions.

However, a number of the Commissioner's decisions not to exercise the subsection 304-10(4) discretion where the taxpayer has breached the payment standards and the sole purpose test in the SISA and the SISR have been affirmed including a decision where the taxpayer breached the conditions of release when the taxpayer withdrew money from their SMSF to maintain their business and then returned the money to the SMSF when the business became viable.

The tax treatment of superannuation benefits in breach of legislative provisions under section 304-10 of the ITAA 1997 is intended to override the concessional tax treatment that ordinarily applied to superannuation benefits under the ITAA 1997 if payments from complying funds were in breach of the payment standards and other rules.

The EM to the Bill which inserted section 304-10 into the ITAA 1997

The Explanatory Memorandum (EM) to Tax Laws Amendment (Simplified Superannuation) Bill 2006 which inserted the section 304-10 into the ITAA 1997 provides further guidance at clauses 2.81, 2.82 and 2.84 as follows:

2.81 The taxation arrangements set out in relation to superannuation benefits paid from a complying superannuation fund do not apply where a superannuation fund has not adhered to requirements set out in section 62 of the Superannuation Industry (Supervision) Act 1993.

2.82 Further, these arrangements do not apply where a person receives an amount or benefit that does not meet the payment standards prescribed un subsection 31(1) or 32(1) of the Superannuation Industry (Supervision) Act 1993 relating to the operation of regulated superannuation funds and regulated approved deposit funds respectively. This means that where a person receives a superannuation benefit that does not meet these requirements, it must be included as part of his or her assessable income and is therefore subject to marginal tax rates.

…

2.84 The Commissioner of Taxation (Commissioner) retains discretion to provide that an amount may be excluded from a person's assessable income and treated as a superannuation benefit where the Commissioner is satisfied that it would be unreasonable to do so. The Commissioner may have regard to the nature of the superannuation fund, where relevant, and any other matter that he or she may consider to be relevant.

The EM to the Bill which inserted section 26AFA and section 26AFB into the ITAA 1936

In your request, you also referred to the legislative history and the intent of former section 26AFA and section 26AFB of the Income Tax Assessment Act 1936 ( ITAA 1936).

The EM to Taxation Laws Amendment Bill (No.4) 1987 provides some additional guidance as to the circumstances for the exercise of the Commissioner's discretion where it discusses the relevant clauses as follows:

n Clauses 9 to 11

n … The purpose of existing section 26AF is to make fully assessable any benefit which a taxpayer receives from an existing or former paragraph 23(ja) or section 23FB superannuation fund otherwise than in accordance with approved terms and conditions applicable to the fund at the time when the benefit is received. … Section 26AF is thus an anti-avoidance provision designed to prevent abuses of the concessions available to certain approved funds.

n Similarly, section 26AFA requires excessive and unauthorised benefits paid to certain taxpayers from an existing or former section 23F fund to be fully taxed in the hands of the recipient unless the Commissioner of Taxation is satisfied that this would be unreasonable in the circumstances. The Commissioner has indicated that this discretion would be exercised where there are no tax avoidance implications and where the excessive benefit arose fortuitously or in other circumstances beyond the effective control of the recipient or the employer.

n …New section 26AFB will assume the discretion currently available under section 26AFA in order to ensure that taxpayers are treated appropriately such as where loss of tax exemption by a fund may be regarded as a sufficient penalty for a breach of the relevant standards. However, the new section will not specify the taxpayers which will be liable to tax on relevant benefits since that could afford scope for avoidance of the provisions and any unintended impact of the provisions will be avoided by virtue of the discretion available to the Commissioner.

Therefore, having regard to the legislative history and the context of the subsection 304-10(4) discretion as provided by the EM to Tax Laws Amendment (Simplified Superannuation) Bill 2006, and the use of the word 'unreasonable' in the corresponding discretionary provisions of former section 26AFA and 26AFB of the ITAA 1936 (as above), it becomes evident the discretion would be exercised only in circumstances where the Commissioner considered it 'unreasonable' to include superannuation benefits paid in breach of legislative requirements in a person's assessable income where:

• it would be in addition to other taxation consequences and

• the breach arose in circumstances beyond the effective control of the recipient.

Applying the above to the facts in considering the exercise of the discretion in your client's circumstances

The Fund was not made a non-complying superannuation fund for the 2012-13 income year (the income year in which the breaches occurred) and the inclusion of the superannuation benefits by the application of subsection 304-10(1) of the ITAA 1997 would not be in addition to other taxation consequences.

It is also clear the breaches did not arise in circumstances beyond the effective control of the recipient of the benefits (your client) who was the sole member and sole director of the corporate trustee of the Fund (the Trustee).

The Trustee was well aware that a condition of release as required by section 34 of the SISA had not been met to allow the release of the benefits to the member.

Therefore, the circumstances of your client's case would not warrant the exercise of the Commissioner's discretion as contemplated by the subsection 304-10(4) discretion.

The SMSF trustee has duties and responsibilities to act in accordance with requirements of superannuation laws including the SISA and the SISR. The SMSF trustee is ultimately responsible for running the SMSF and needs to comply with the fund's trust deed and legislative requirements.

The purposes of setting up the SMSF is to provide benefits for the member's retirement and if benefits are unlawfully released, significant penalties can apply to the SMSF and the recipient of the early released benefits. It is clear the law stipulates that fund assets cannot be used for personal or business purposes under any circumstances because the SMSF assets enjoy concessional tax treatment because the SMSF is maintained for the provision of retirement benefits.

Conclusion

The Commissioner's discretion under subsection 304-10(4)of the ITAA 1997 is therefore not to be exercised in the present case as it is not considered 'unreasonable' to include the superannuation benefits in the recipient's assessable income as the breaches of section 34 and section 62 of the SISA are considered serious and did not stem from circumstances beyond the effective control of the trustee.

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