• The impact of this case on ATO policy is discussed in Decision Impact Statement: Pabian Park Pty Ltd Superannuation Benefits Fund v Federal Commissioner of Taxation (Published 28 August 2012).

PABIAN PARK PTY LTD SUPERANNUATION BENEFITS FUND v FC of T

Members:
JL Redfern SM

Tribunal:
Administrative Appeals Tribunal, Sydney

MEDIA NEUTRAL CITATION: [2012] AATA 375

Decision date: 21 June 2012

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JL Redfern (Senior Member)

BACKGROUND

1. The applicants, Mr Wladyslaw Pabian and Mrs Sylvia Pabian, are the trustees of the Pabian Park Pty Ltd Superannuation Benefits Fund (the Fund). The Fund was established on 7 June 1994 and is a self-managed superannuation fund for the purposes of the Superannuation Industry (Supervision) Act 1993 (the SIS Act). It was accepted as a "complying superannuation fund" by the Commissioner of Taxation (the Commissioner) for a number of years and as such enjoyed certain tax benefits available under tax legislation.

2. Mr and Mrs Pabian are, and were at all relevant times, also directors of Pabian Park Pty Ltd (Pabian Park). Pabian Park was incorporated in the 1960s and in recent years was involved in property development. Between February 2004 and February 2007, the Fund loaned $307,000 to Pabian Park. Pabian Park repaid $101,000 with interest, leaving a balance of $206,000. The Fund loaned a further $40,000 to Pabian Park on 2 August 2007.

3. On 31 October 2008, the Commissioner commenced an audit of the Fund for compliance with the regulatory provisions of the SIS Act. The auditors identified a breach of the SIS Act in that the loan from the Fund to Pabian Park was an 'in-house asset' which represented more than 5% of the value of the Fund. On 13 March 2009, Mr and Mrs Pabian provided an undertaking to the Commissioner, which was accepted on 18 March 2009, that they would repay the loan from Pabian Park to the Fund by 30 September 2009.

4. The loan was not repaid by this date and on 18 November 2009, the Commissioner issued a notice of non-compliance in respect of the year ended 30 June 2006. It is common ground that a once a fund has been issued with a notice of non-compliance the fund remains non-complying unless and until the Commissioner sets aside the notice of non-compliance or issues a notice that the fund is complying.

5. As a result of the notice, the Fund lost the benefit of concessional tax rates and was assessed for additional tax for each of the years ended 30 June 2006 and 2007.

6. Mr and Mrs Pabian applied for a review of the decision but the decision was confirmed, and notified to Mr and Mrs Pabian by letter dated 22 April 2010. On 15 May 2010, Mr and Mrs Pabian applied to the Tribunal for review of this decision.

ISSUES

7. There is no dispute the applicant has breached a number of regulatory provisions of the SIS Act.

8. The issue is whether, in the circumstances, the notice of non-compliance should be set aside in respect of the income year ended 30 June 2006.

LEGISLATIVE FRAMEWORK

9. 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).

10. 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: s 3(1) of the SIS Act. The regulator of self-managed superannuation funds is the Commissioner of Taxation (the Commissioner).

11. 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.

12. Section 40(1) of the SIS Act provides that the Commissioner may give a notice to a trustee of an entity stating "whether the entity is or is not a complying superannuation fund … in relation to a year of income specified in the notice". Section 40(2) provides that where the Commissioner gives a notice to a trustee stating the entity is not a complying superannuation fund; the notice must set out the reasons why the Commissioner has so stated. Giving a notice under s 40(1) is a discretionary matter and the Commissioner has issued Practice Statement Law Administration 2006/19 Self-managed superannuation funds - notice of non-compliance (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.

13. Under s 42A(1) of the SIS Act, 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 in this case, and the entity passes the test set out in s 42A(5).

14. 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.

15. 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. It is also relevant to note, as stated in PS LA 2006/19, that the Commissioner considers the factors set out in s 45A(5)(b) for issuing a notice of compliance for a non-complying fund are "equally relevant" in making a decision on whether to give a notice of non-compliance. The provisions are inter-related as it is implicit that the Commissioner has refused to give a notice of compliance when a notice of non-compliance is issued under s 40 (1) of the SIS Act.

16. 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). If the superannuation fund is non-complying, has been given a notice of non-compliance but becomes complying in a subsequent year of income, the Commissioner is obliged to give a notice of compliance in respect of that year (s 41(2) of the SIS Act).

17. The ITRA provides concessional rates of tax for a trustee of a complying superannuation fund but the tax rate in respect of the taxable income of a non-complying fund was at the relevant time 47% (s 26(1) of the ITRA). 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).

18. 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 benefit of concessional tax rates unless and until the trustee is served with a notice that it is non-complying. Once served with such a notice, concessional rates will no longer apply to the self-managed superannuation fund and tax will be assessed on net funds in the previous income years as well as on income in the current year of assessment.

19. 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 this case, amended assessments have been issued to Mr and Mrs Pabian as trustees for the Fund as a result of the audit and the gross tax assessed was increased from $8,454.15 to $145,618.69.

20. The Commissioner contends that Mr and Mrs Pabian, as trustees of the Fund, have contravened ss 62, 83, 84 and 109 of the SIS Act. Sections 62, 84 and 109 are civil penalty provisions under s 193 of the SIS Act and are therefore "regulatory provisions" for the purposes of s 42A(5) of the SIS Act.

21. 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 84 requires a trustee of a regulated superannuation fund to take "all reasonable steps" to ensure that the rules in relation to "in-house assets" are complied with by the fund. An in-house asset is a related party loan or investment. The in-house assets rule provides that if the market value ratio of the fund's in-house assets exceeds 5%, the trustee of the fund must not acquire an in-house asset. If the market value ratio does not exceed 5% but the acquisition would result in the market value of the fund's in-house assets exceeding 5%, the trustee must not acquire the in-house asset (s 83 of the SIS Act). Section 109 requires investment by a superannuation entity to be made and maintained on an arm's length basis.

22. 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 relevant because an undertaking was offered by Mr and Mrs Pabian and accepted by Commissioner, but not complied with, prior to the issue of the notice of non-compliance.

23. Section 344(1) of the SIS Act provides that a person affected by a reviewable decision may request a review and the Regulator (in this case, the Commissioner) must reconsider the decision and confirm, revoke or vary the decision. Section 344(8) provides that an application for review may be made to this Tribunal in respect of decisions that have been either confirmed or varied.

THE EVIDENCE

24. In 2003, Mr and Mrs Pabian purchased land in Yamba on the north coast of New South Wales for $495,000 with the intention of subdividing the block into 6 lots and engaging Pabian Park to construct and sell residential developments. They borrowed money from the National Australia Bank (NAB) to fund the purchase and to finance the development costs. They subsequently made other purchases for property development, also funded by the NAB. By September 2005 they owed approximately $1.53 million, secured by mortgages over property owned by Mr and Mrs Pabian and a charge from Pabian Park, which was a guarantor for the loan. There were arrangements in place between Mr and Mrs Pabian, which were not in evidence but were accepted by the parties, whereby Pabian Park paid the interest on the loans.

25. In February and May 2004 a total of $50,000 was withdrawn from the bank account of the Fund and paid to Pabian Park to pay for operating costs for the business. Mr Pabian agreed that at this time the Fund was used as an "immediate source of funds" for the business. On 30 June 2004 the amount was repaid, together with interest of $1,155.

26. From August to December 2004 the Fund transferred a total of $52,000 to Pabian Park, which repaid the sum, together with interest of $1,924, on 29 December 2004. In the years ended 30 June 2006 and 30 June 2007, the Fund transferred a total of $60,000 and $146,000 respectively to or for the benefit of Pabian Park and/or Mr and Mrs Pabian. It was not in dispute that these funds were used for the business operations of Pabian Park and, to pay interest on the NAB loan. The borrowers were Mr and Mrs Pabian.

27. In May 2006 and February 2007 the Fund sold assets, being shares in listed companies, and the proceeds (approximately $164,000) were paid into the bank account of the Fund. These funds were ultimately paid to Pabian Park. While three of the blocks from the Yamba development had been developed by June 2006, they were not sold until 2007 and the proceeds "did not generate the funds anticipated". There were further delays in the development and the project did not generate sufficient funds to pay interest or reduce the debt to the NAB. According to the Applicants' Statement of Facts Issues and Contentions, they "had no option other than to use their only source of funds", being their superannuation funds, to fund the loan and complete the last stage of the project.

28. Neither party provided the financial statements for the Fund for the year ended 30 June 2005 but according to the financial statements for 2006 the Fund held total assets comprising $521,317, being $350,000 for shares in listed companies, $111,317 cash and $60,000 for loan to Pabian Park. The loan represented over 10% of the net assets of the Fund and there is no dispute that this loan breached the in-house assets rule in the year ended 30 June 2006. The financial statements for 2007 show that the Fund held total assets of $506,346 comprising $217,500 for shares in listed companies, $82,846 cash and $206,000 for a loan to Pabian Park. This loan represented over 40% of the net assets of the Fund, in breach of the in-house assets rule in the year ended 30 June 2007.

29. On or about February 2007, after an advance of $50,000 was made from the Fund to Pabian Park, a loan agreement was prepared between the Fund and Pabian Park dated 1 August 2005. The agreement provided that the Fund would lend Pabian Park $206,000 and would pay interest at the rate of 8.05% per annum on an annual basis. It was signed by Mr and Mrs Pabian. There was no specific provision in relation to repayment of the principal, other than as follows:

Upon the turn around of the property market, the Borrower estimates repaying the Loan in full by June 2010.

30. On 27 June 2007, Pabian Park paid the Fund $14,310 in interest.

31. On 2 August 2007 the Fund transferred $40,000 to Pabian Park for various business expenses, making a total of $246,000 owing from Pabian Park to the Fund from this date.

32. By letter dated 9 September 2008, the auditors of the Fund, W Clark & Dunlop Pty Ltd, notified Mr and Mrs Pabian that the Fund did not comply with the SIS Act as the loan of $206,000 exceeded 5% of the Fund's assets. This contravention was also notified to the Australian Taxation Office (ATO) and, based on this notification, the Fund was audited.

33. On 28 November 2008, there were telephone discussions between Ms Jane Kinsley, an accountant from W Clark & Dunlop Pty Ltd, and the ATO about the proposal to repay the loan by June 2010. By letter dated 12 December 2008, the ATO advised that this proposal was unacceptable but noted Mr and Mrs Pabian wanted to propose a new undertaking. The ATO also provided a copy of Practice Statement Law Administration 2006/18 Self-managed superannuation funds - enforceable undertakings (PS LA 2006/18). PS LA 2006/18 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.

34. There were further discussions between Mr White, who had taken over the conduct of the matter for Mr and Mrs Pabian, and the ATO in January 2009 to the effect that the Fund would be repaid when two of the properties from the Yamba development were sold. According to a letter from the ATO to Mr and Mrs Pabian dated 18 February 2009 an undertaking dated 30 January 2009, a copy of which was not provided by either party, was considered to be "unacceptable in its current format" because it was "too open-ended" and did not provide an actual date for rectification. Mr and Mrs Pabian were invited to revise the undertaking.

35. Mr and Mrs Pabian provided a revised undertaking dated 13 March 2009, which provided Pabian Park would repay the loan on the sale of the Yamba properties (Lots 1 and 2) or by 30 September 2009. This undertaking was accepted on 18 March 2009.

36. The Yamba properties were not sold in 2009 nor was the Fund repaid by 30 September 2009. By facsimile sent to the ATO on 8 October 2009 Mr White advised that the Yamba properties had not been sold even though there had been a "substantial reduction" in the listed price and the ability to comply with the undertaking in the "near future is not expected".

37. By letter dated 20 October 2009, the ATO sent a 'Position Paper' to Mr and Mrs Pabian setting out the reasons why the ATO was considering issuing a notice of non-compliance in respect of the Fund for the year 30 June 2006. On 17 November 2009 Mr Pabian sought an extension to respond but after a discussion between Mr White and an ATO officer it was suggested that Mr and Mrs Pabian should wait for the notice of non-compliance to issue and seek a review of the decision. A notice was issued on 18 November 2009.

38. It appears from a file note and email exchanged between Mr White and the ATO that Mrs Pabian was ill at about this time with a heart condition that had necessitated treatment in Sydney.

39. Mr Pabian sought a review by letter dated 10 February 2010. He noted that the sums provided were used to maintain company overheads, wages and superannuation contributions and the bank's confidence in the company. The recession had affected sales of properties in the Yamba development (Pabian Park had made a loss of $169,000); he had been unable to obtain alternative or further finance and was concerned that foreclosure by the bank would result in a "fire sale" of the Yamba properties and their home, which was Lot 3. The notice of non-compliance would affect the Fund as the remaining assets would have to be sold to pay the amended assessment. By letter dated 22 April 2010, the delegate of the Commissioner notified Mr and Mrs Pabian that the Commissioner would not revoke or vary the notice of non-compliance.

40. On 1 June 2010, Pabian Park entered into a loan of $246,000 with the NAB and repaid the loan to the Fund at that time. The Fund then made distributions to Mr and Mrs Pabian, who then repaid the NAB loan.

41. At the time the Fund commenced making advances to Pabian Park, Mr and Mrs Pabian were the registered proprietors of the development at Yamba (6 lots) and 110 acres in the Pillar Valley. They sold the Pillar Valley property in April 2007 and Lots 5, 6 and 4 of the Yamba development in June, September and October 2007 respectively. They purchased property in South Grafton in November 2007 (Berger Street) and in March 2010 (Fairway Drive) with borrowings from the NAB. Two further lots of the Yamba development were sold in January and February 2010 (Lots 1 and 2). The proceeds of sale of the various properties were used to repay the debt to the NAB. The South Grafton property was for development and Fairway Drive was a new residence for Mr and Mrs Pabian.

42. Mrs Pabian gave evidence that while she was a director of Pabian Park and a trustee of the Fund, she knew little about the operation of the Fund. She left the management of the financial affairs of the Fund to Mr Pabian although she was aware that money was transferred from the Fund to Pabian Park "to help finalise the development that we were doing at Yamba". When questioned about her obligations as a trustee of a self-managed superannuation fund, Mrs Pabian said she did not understand her obligations as a trustee other than "to be honest and do the right thing".

43. Mr Pabian gave evidence that he retained accountants to ensure the Fund complied with the "technical aspects" of the relevant legislation. He made the investments for the Fund but was not given, nor did he seek, advice on his obligations under the SIS legislation or the trust deed. Mr Pabian said the Fund was a "ready source of funds" for Pabian Park and was not aware of the in-house assets rule until he received documents from the ATO, presumably by late 2008/ early 2009. Pabian Park was unable to finance the borrowings to the NAB and interests was being capitalised pending the sale of the Yamba development. The Fund was being used to finance interest and development costs as Mr Pabian was unable to source alternative finance. Mr Pabian said that banks were not prepared to make loans for property development as it was "too speculative". According to Mr Pabian:

- we had been running this development thing now for years, and it was on a basis of capitalising the interests in - so, consequently, it was in hindsight, quite risky in its own self, but each time the numbers looked inviting, to say the least.

44. The principal owing to the NAB had reduced to $890,000 by January 2010 and Mr and Mrs Pabian still owned Lots 1, 2 and 3 of the Yamba development and the Berger Street property. They sold Lots 1 and 2 by February 2010 for about $730,000 and retained Lot 3 but also purchased Fairway Drive in March 2010 as their new residence. Mr Pabian was asked why he and Mrs Pabian did not repay the Fund before 1 June 2010. Mr Pabian said that he was not aware of the breach but after he became aware, he offered to repay the Fund by June 2010 to allow for the sale of Lots 1 and 2 of the Yamba development. The ATO would not accept this and he therefore offered, in good faith, to repay by 30 September 2009. However, he was unable to sell the properties until early 2010. Mr Pabian said he is not sure why he and Mrs Pabian did not repay the Fund at that time other than that there was "too much going on".

45. There was evidence that Pabian Park borrowed $34,297, which was paid to the Fund on 3 August 2010 as interest, but subsequently withdrawn on 6 August 2010. This was said to be a distribution to Mr and Mrs Pabian from the Fund. In addition, there was a schedule provided to the Tribunal by Mr White recording amounts said to comprise interest paid by Pabian Park to the Fund or payments made by Pabian Park to the ATO on behalf of the Fund in lieu of interest. The total was $65,633. The only documentary evidence provided to substantiate these payments was for the two interest payments of $14,310 and $34,297.

46. Mr Pabian said he now understood his obligations. Mr and Mrs Pabian had undertaken to the ATO in March 2009 that they would not use the Fund for further borrowings and they had not done so. Even though Pabian Park had not repaid the Fund by 30 September 2009 in accordance with the undertaking, Mr Pabian said they had otherwise complied with the undertaking. Moreover, Pabian Park had repaid the Fund and the breach had been rectified.

SUBMISSIONS OF THE PARTIES AND CONSIDERATION

47. If the Commissioner finds that a self-managed superannuation fund is non-complying because the trustees have contravened one or more of the regulatory provisions, he has a number of options. Section 40(1) gives the Commissioner discretion to issue a notice about whether a self-managed superannuation fund is complying. The Commissioner may decide not to issue any notice but take other action, such as accepting an enforceable undertaking or seeking civil penalties or the disqualification of trustees. He may take no action. If the Commissioner does not issue a notice about compliance, the tax treatment of the fund will remain unchanged. The Commissioner has discretion, although s 42A(5) sets out the matters to be considered if he decides to issue a notice that the fund is complying even if it is not. Those matters are: the tax consequences arising from the fund being treated as non-complying, the seriousness of the contraventions and all other relevant circumstances.

48. The Commissioner has issued PS LA 2006/19 as a guide as to the factors he will consider when deciding whether to issue a notice under s 40(1) of the SIS Act. PS LA 2006/19 draws substantially on the factors set out in s 42A(5) of the SIS Act. It 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. It provides useful insight for a decision-maker about the relevant regulatory issues, having regard to the experience of, and policy developed by, the Commissioner in administering and enforcing the SIS legislation.

49. 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 ATC 5105; (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 Australian 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…

50. There are three factors to 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 the objects of the SIS Act, as further explained by Logan J, and should be followed.

51. Mr Pabian contends he and Mrs Pabian did not know about the in-house assets rule when they made the payments to Pabian Park from 2005 to 2007 but in any event they had no choice at that time as they had no income to service the NAB loan and could not obtain alternative finance. Once they became aware of the rule they did not lend further money to Pabian Park from the Fund. The Fund was repaid and interest was paid on the loan. There was a delay in the repayment because Mr Pabian did not want a "fire sale" of the remaining lots in the Yamba development? they were affected by the 'Global Financial Crisis'. Ultimately there was no risk or detriment to the Fund but if the notice of non-compliance was not revoked the remaining assets in the Fund would be significantly depleted in paying the amended assessment and Mr and Mrs Pabian would have little or no retirement savings as a result. This would be a harsh outcome in the circumstances.

52. The Commissioner contends Mr and Mrs Pabian breached a number of the regulatory provisions of the SIS legislation by making loans to Pabian Park in 2006 and 2007. The loans were made over a two year period and were significant - they represented over 40% of the assets of the Fund by 30 June 2007. The Pabians used the Fund as a "lender of last resort" for the business and this was inappropriate. The contraventions were numerous, the loans related to the activities of Pabian Park as a developer, which Mr Pabian conceded were risky, and they were not documented or on commercial terms. A loan agreement was not entered into until after the loans had been made. With the exception of one payment, interest on the loan was not paid until August 2010 and there is no documentary evidence of the other payments alleged to have been made by Pabian Park to the ATO on behalf of the Fund of approximately $17,000. Importantly, Mr and Mrs Pabian knew about the breaches at the time they were notified by the auditors in September 2008 but took no steps to repay or reduce the loan until June 2010 and did not comply with an enforceable undertaking to repay the Fund by 30 September 2009. Even though the tax consequences are significant, the contraventions were serious and should be given great weight.

TAX CONSEQUENCES

53. 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.

54. When a superannuation fund is found to be non-complying, not only does it lose its concessional rates but under s 288A of the ITAA the trustee will be liable to pay tax on the assessable income in respect of the year it became non-complying and will be liable to pay tax on the net previous income in respect of the previous years of income, which will be calculated by reference to the market value of the assets in the immediately preceding year, less undeducted contributions.

55. As a result of the Fund becoming non-complying for the year ended 30 June 2006, the taxable income for the Fund increased from $56,361 to $309,827, with gross tax increased from $8,454.15 to $145,618.69. In the review decision of 22 April 2010, the delegate of the Commissioner noted that impact on the Fund with assets of $514,015 as at 30 June 2006 was "serious but not unreasonable". The Commissioner conceded the tax consequences for the year ended 30 June 2006 was a "material factor" that should be given consideration and also noted that there would be taxation consequences for subsequent years unless and until the Commissioner gave the Fund notice that it was complying. The Fund was not complying until the loan from Pabian Park was repaid in June 2010. There was no evidence about the further tax consequences to the Fund and whether amended assessments were or are to be issued for 2007 to 2010. As no amended assessments were produced or referred to by either party, I have assumed the matter was deferred pending this review.

56. I nonetheless accept the Commissioner's submission that the tax consequences for the Fund are likely to be exacerbated for subsequent tax years. I also accept that the tax consequences are significant and will leave Mr and Mrs Pabian with minimal savings in their Fund. However, it should be noted that in June 2010 they received a distribution from the Fund of at least $246,000 in causing Pabian Park to repay the Fund. While Mr and Mrs Pabian may not agree because they did not receive any cash as a result of the round robin payments, this was a benefit to them as it represented a repayment of what was, in effect, an early release of the preserved benefits in their self-managed superannuation fund. As Mr Pabian agreed, the release of these funds allowed Mr and Mrs Pabian to maintain the value of their personal assets and assisted their business, which generated income for them. Mr and Mrs Pabian are the owners of three properties (vacant land in Berger Street, Lot 3 at Yamba and Fairway Drive) and while they are mortgaged to the NAB, Mr and Mrs Pabian have equity in those assets, largely because they were able to use the Fund as a lender of last resort.

57. Adverse tax consequences will be a significant but not determinative factor which must be weighed against other factors such as the seriousness of the contraventions and the attitude of the trustees in complying with the regulatory provisions of the SIS Act.

SERIOUSNESS OF THE CONTRAVENTIONS

58. Under PS LA 2006/19, the following factors should be considered when assessing the seriousness of the contravention:

• • The behaviour of the trustee in relation to the contravention;
• • The extent to which the contravention affects the fund's assets;
• • The extent to which those assets are exposed to financial risk and whether there is any loss in the value of the fund;
• • The number and duration of the contraventions over time; and
• • The nature of the contraventions in the overall scheme of the legislation.

59. I am satisfied that making unsecured advances from the Fund to Pabian Park on a regular basis over a two year period was a breach of ss 62 and 84 of the SIS Act. There is evidence that the loans were not on commercial terms and as such were also in breach of s 109 of the SIS Act. There is no dispute, nor can there be based on the evidence, that the loans from the Fund to Pabian Park breached the in-house assets rule as at 30 June 2006. The loans represented over 10% of the Fund and by 30 June 2007 this had increased to over 40% of the assets. In my view these contraventions were serious and Mr and Mrs Pabian's ignorance of the regulatory provisions of the SIS Act is no excuse.

60. Mr and Mrs Pabian were the trustees of a self-managed superannuation fund which received the benefit of concessional taxation treatment designed to encourage retirement savings. The regulatory provisions of the SIS Act are intended to make provision for the prudent management of retirement savings and the 'sole purpose' test, the in-house assets rules and the rules relating to 'arm's length' investments are important regulatory provisions. Their importance is underscored by the fact that they are civil penalty provisions, the breach of which may lead to serious consequences, such as monetary penalties, disqualification and, relevantly, the issue of a notice of non-compliance under s 40 of the SIS Act. It was clear from the evidence of Mr Pabian that he did not appreciate the significance of the regulatory provisions and referred to them as "technical aspects". He did not read the trust deed. Mrs Pabian said she did not know her obligations as trustee of a superannuation fund. Of particular concern is the fact that Mr Pabian must have appreciated there was a breach of these provisions when he and Mrs Pabian were notified of this by the auditors. He was involved in the management of the Fund. Moreover, Mr and Mrs Pabian executed an enforceable undertaking on 18 March 2009, which highlighted the breach and provided for repayment of the Fund.

61. Mr and Mrs Pabian originally proposed repayment by June 2010 but this was not accepted by the ATO. They did not comply with the undertaking nor did they seek to repay the loan at the earliest possible opportunity after the due date for compliance, which was when they had sold Lots 1 and 2 of the Yamba development by February 2010. Instead they chose to increase their indebtedness and purchase Fairway Drive. Mr Pabian's only explanation for the delay was that there was "too much going on", although it seems Mrs Pabian had been ill prior to this. There was no evidence about whether this was still an issue at this time.

62. The breaches were serious because the loans were made over a period of two years, they related to risky investments as a lender of last resort and continued, notwithstanding, once Mr and Mrs Pabian were warned of the breach, for a further 18 months. I accept Mr and Mrs Pabian did not intend to breach the SIS Act at the outset but they did so from at least August 2005 and did nothing to inform themselves of their obligations. Using the assets of the Fund for their business did not cause loss to the Fund because the loan was ultimately repaid but the Fund did not appreciate in value over this period and I am not satisfied on the available evidence that commercial interest was paid. It is also relevant to consider that the loan was unsecured and Pabian Park did not own the assets which were the subject of the developments. These were owned by Mr and Mrs Pabian but in any event were mortgaged to the NAB. The Fund would have had limited recourse if the loan had not been repaid

63. In my view, the nature and extent of the contraventions are serious but they were not wilful.

ALL OTHER RELEVANT CIRCUMSTANCES

64. PS LA 2006/19 identifies the following matters as relevant circumstances to consider when deciding whether to exercise the discretion to treat a non-complying fund as complying:

• • Whether the trustee has rectified the contravention, entered into an enforceable undertaking or taken action to prevent the contravention recurring;
• • The trustee's level of skill and knowledge;
• • The compliance history of the fund before and after the contraventions; and
• • The events which lead to the contravention and whether these influenced the trustee's decision, including serious illness.

65. I accept that Mr Pabian, while an experienced business man, had limited skill and knowledge about the SIS Act and the regulatory provisions of the legislation. Mrs Pabian had even less understanding and left the management of these matters to Mr Pabian. Mr Pabian retained an accountant to monitor compliance but did not seek advice on his obligations as trustee. I therefore give this factor little weight. On the other hand, Mr and Mrs Pabian retained auditors, as they were required to do, and those auditors notified the ATO of the contraventions. Mr and Mrs Pabian did attempt to engage with the ATO about the breach through their accountant and offered an enforceable undertaking soon after the breach was identified. The difficulty is they did not comply with the undertaking. Mr Pabian said they could not sell Lots 1 and 2 of the Yamba development by 30 September 2009 because of the depressed market. He also said the NAB would not allow the Fund to be repaid. The NAB was first mortgagee, wanted the indebtedness to be reduced and was entitled to the proceeds. If this was the case, it is difficult to understand why Mr and Mrs Pabian gave the undertaking of March 2009, which contemplated the repayment of the loan to the Fund from the sale of the Yamba properties.

66. I do not accept the evidence of Mr Pabian that the Fund could not be repaid immediately upon the sale of Lots 1 and 2 of the Yamba development although I accept his evidence that the properties could not be sold within the timeframe agreed, which was corroborated in part by contemporaneous file notes of conversations between Mr White and the ATO.

67. Even if it is accepted that Mr and Mrs Pabian could not sell the Yamba properties within the time nominated in their undertaking, it is relevant to note that Mr and Mrs Pabian made the choice to purchase a new property in March 2010 rather than cause Pabian Park to repay the Fund. This reflects poorly on their attitude to compliance and their understanding of the seriousness of the existing breaches.

68. During the hearing, I raised an issue about whether the round robin payment in June 2010 from Pabian Park to the Fund was properly effected as a distribution to Mr and Mrs Pabian within the terms of the SIS legislation. This issue was not resolved in the hearing or addressed in subsequent submissions. The Commissioner accepted that Mr and Mrs Pabian had "rectified" the breach by reason of this payment but submitted that rectification was merely one factor to be considered in determining the exercise of the discretion under s 42A(5) of the SIS Act. The fact there was no evidence (or at least insufficient evidence) that a commercial rate of interest was paid to the Fund was relevant. The Commissioner also submitted that the Tribunal could not be satisfied the Fund was fully restored and the delay in repayment and failure to comply with the undertaking are factors that weigh against the exercise of discretion in favour of Mr and Mrs Pabian.

69. While I accept these submissions, there were mitigating circumstances. There is evidence Mrs Pabian was unwell in late 2009/early 2010 and Mr and Mrs Pabian had to travel to Sydney in this period. Mr Pabian was no doubt distracted. In addition, after the notice of non-compliance was issued the focus shifted to dealing with submissions about the reviews, rather than addressing rectification, and communications became more formal. It is also relevant that Mr and Mrs Pabian have managed the Fund since 1994, there is no history of non-compliance and by 2006 the assets of the Fund had grown to over $514,000.

CONCLUSION ON EXERCISE OF DISCRETION

70. I am satisfied the contraventions of Mr and Mrs Pabian were serious but the impact on the Fund has not been significant. The Fund was no longer in breach from June 2010, although I accept there is a question about whether there has been full and appropriate reparation. Mr and Mrs Pabian did not discharge their duties as trustees of their self-managed superannuation fund and pleaded ignorance as a defence. This defence is not persuasive, particularly after late 2008/ early 2009, when they must have been aware of the breach - which was continuing.

71. On the other hand, the tax consequences of the issue of the notice of non-compliance are likely to deplete most if not all of the assets of the Fund. Mr and Mrs Pabian are both over 65 years old and there will be little opportunity to rebuild their retirement savings. They own assets but those assets are encumbered. The Fund has operated since 1994 and there is no evidence of non-compliance by either the Fund or Mr and Mrs Pabian, other than the loans in 2006 and 2007. The loans were documented and they were repaid. When all of the circumstances are considered, Mr and Mrs Pabian's most significant breach was their failure to rectify the contravention of the in-house assets rule in a timely manner, notwithstanding they were warned of the breach by the auditors and the ATO. Their delay, when so much was at stake, is puzzling. If they had complied with the undertaking or sought and obtained an extension of the undertaking until February 2010 and repaid the Fund at this time, it is unlikely that a notice of non-compliance would have been issued.

72. When it was clear they would not be able to comply with the undertaking, Mr and Mrs Pabian should have approached the ATO but they did not take any steps to do so until after the time for compliance had expired. There was no discussion about these options or details about when the properties would be sold. Faced with advice that repayment was not expected in the "near future", it is not surprising that the Commissioner gave notice about the proposed issue of a notice of non-compliance. Yet both Yamba properties were sold within three months of the issue of the notice. This sequence of events is unfortunate as if there had been better proactive discussion with the Commissioner at this time, this dispute may have been avoided.

73. The following observations of Senior Member Carstairs in Re
JNVQ and Commissioner of Taxation 09 ESL 08; (2009) 74 ATR 730; [2009] AATA 522 at [41], in respect of the exercise of the discretion under s 42A(5) are apposite:

… 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.

74. This case is finely balanced. The contraventions were serious and Mr and Mrs Pabian failed to discharge their duties to rectify the breach in a timely manner. Against this, Mr and Mrs Pabian caused Pabian Park to repay the Fund, albeit later than promised, and the tax consequences on the Fund, and hence their retirement savings, are significant.

75. At the heart of the case is Mr and Mrs Pabian's apparent failure to appreciate the seriousness of the issue after they were notified of the breach but more particularly after they executed an enforceable undertaking, with which they did not comply. This was a serious error of judgement but in my view it would be disproportionately harsh not to exercise the discretion in their favour. There is no history of non-compliance, which is significant given they managed the Fund without incident for approximately 12 years, and there is evidence, which has not been contradicted, that the Fund was made compliant in June 2010. There is no evidence that the Fund has breached any regulatory provisions since this time.

76. In the circumstances of this case and weighing up all the factors, I am satisfied that it would not be inconsistent with the objects of the SIS Act to exercise the discretion in favour of the Fund in respect of the year ended 30 June 2006, notwithstanding the breach of certain regulatory provisions of the SIS Act. I therefore set aside the decision under review, being the decision to issue the notice if non-compliance. Under s 45(3) of the SIS Act, the notice is "taken never to have been given" and as such the Fund remains a complying superannuation fund.