There are generally 2 types of penalties the ATO can impose on SMSF Trustees for contraventions which have taken place:
Administrative Penalties – this is generally for minor breaches of the SIS Act. The ATO will normally request the Trustees to take measures to amend or correct the breach and providing this is done in a timely manner no further action will be taken.
Civil Penalties – The ATO can apply to the courts to impose civil penalties in certain cases. These penalties are obviously more substantial and relate to serious breaches of the SIS Act which would relate to:
- Breaches of the Sole Purpose Test;
- Lending to or providing financial assistance to members;
- A SMSF borrowing;
- The in-house asset rules;
- Investing with related parties (where allowed) on an arm’s length basis.
Penalties are intended to achieve several objectives, including deterrence, denunciation and punishment. In determining the amount of the penalty, the courts will take into account:
- The nature & extent of the contravening conduct;
- The amount of any loss or damage caused;
- The size of the organisation;
- The deliberateness of the contravention;
- The timeframe over which the breaches were committed;
- The degree of co-operation of the person concerned;
- The past record of the person and their financial position;
- Amounts already paid by way of compensation;
- Level of contrition.
Examples of Civil Penalties which have been issued over the last few years by the Courts for SMSF breaches include:
- Penalties of $10,000 where Trustees had paid an amount substantially greater than market value when purchasing an asset from a member (Case – Derstepanian);
- Penalties totalling $257,000 for breaches of in-house asset rules where the value of the in-house assets were “artificially” reduced to circumvent the rules (Case – Holloway);
- Penalties and costs totalling $54,000 for breaches relating to financial assistance to members and in-house asset rules (Case- Rodriguez);
- Penalties of $30,000 where Trustees had sold the principal asset of their SMSF to help pay Company debts (Case – Fitzgeralds);
- Penalties of $50,000 for multiple, deliberate breaches of Sole Purpose Test, in-house asset rules (Case – Parker);
How to avoid the prospect of penalties?
If you always keep in mind the Sole Purpose Test (an SMSF should provide retirement, death or disability benefits for members) then this should keep you out of most tricky situations.
An SMSF is not a bank, or a source of temporary funds you can access for your business, regardless of whether you pay the money back with market rate interest.
If you are unsure about whether a transaction you are considering satisfies the SIS rules, check with a professional adviser first. Do not get your advice from a friend, neighbour, or someone you know who has told you they have put a similar transaction in place. The cost of the initial advice will be negligible compared to the potential penalties you could face.