Having worked for the Australian Taxation Office (ATO) as a senior compliance officer for the past 17 years has motivated me to write articles to assist SMSF professionals to understand the tax treatment of some actions of their SMSF clients.
One particularly important topic is the tax treatment of money illegally withdrawn by members who have not met the Payment Standards and Conditions of Release under Regulation 6 of the Superannuation Industry (Supervision) Regulations 1994. SMSF professionals often do not know how to treat these payments withdrawals.
Money illegally withdrawn from an SMSF in the year it was established
There are various scheme promoters who take advantage of vulnerable people experiencing financial hardship by encouraging them to establish their own SMSF by rolling money over from their retail superannuation fund. They convince these people that because they are trustees of their SMSF, once the money is in their SMSF’s bank account, they can use it any way they like – perhaps even get out of financial difficulties. Once the money is rolled into an SMSF, the promoters take their fees and leave the SMSF trustee to deal with the ATO.
As a consequence, most newly established SMSFs are closely monitored by the ATO. If the ATO discovers that money has been rolled into an SMSF, not for the sole purpose of providing retirement benefits for members, but for their immediate benefit, it may decide not to issue the SMSF with a notice of compliance when the fund lodges its first annual tax return. This means the SMSF is a non-complying superannuation fund and would not be entitled to any tax concessions.
Not only would the SMSF’s accountant need to declare the entire amount rolled into the SMSF as a lump sum superannuation benefit, paid to the member of the SMSF in their personal tax return, the SMSF’s income tax return would need to be assessed at the non-compliant tax rate. This is because for the money to be treated as an effective rollover and exempt from income tax, it needs to be rolled from a regulated complying superannuation fund to another regulated complying superannuation fund. As the money has been rolled over into a non-complying SMSF, it is not treated as an effective rollover. The money is treated as a lump sum benefit paid by the retail fund directly to the SMSF member under Division 301 of the Income Tax Assessment Act 1997.
If the money is not declared in your client’s tax return, the ATO may amend your client’s tax return by including the rolled over amount and impose penalties for not declaring the money illegally withdrawn from the retail superannuation fund.
Money withdrawn from an SMSF in subsequent years
Let’s say your client’s SMSF has been established for a number of years and then your client faced some financial hardship and withdrew money from their SMSF without meeting a condition of release. If you discover this, any money withdrawn needs to be included as normal income in your client’s personal tax return assessed at their marginal tax rate under section 304-10 of the Income Tax Assessment Act 1997. Of course the ATO may also take other compliance action such as issuing the SMSF with a notice of non-compliance and/or disqualifying the member from being a trustee of the SMSF.
Treating the money illegally withdrawn from the SMSF as loan
If you discover your clients were not aware that they cannot loan SMSF money to themselves, but have done so, you may be able to treat the action of your clients as a contravention of section 65 of the Superannuation Industry (Supervision) Act 1993. However, for a transaction to be treated as a loan, the actions of the SMSF and the members need to show characteristics of a loan transaction. To show this, there must be a written loan agreement between the SMSF and the member; interest should be charged by the SMSF on the loan, and; repayments made to the SMSF by the member. If the ATO allows for the illegally withdrawn money to be treated as a loan, it may request the member to repay the money plus interest incurred on the loan. The actions of the member and the SMSF need to clearly demonstrate that the payment has been treated as a loan. It is not enough to have evidence of a loan agreement if the actions of the member and the SMSF do not demonstrate that an actual loan arrangement has been put in place.