This decision of the Administrative Review Tribunal set aside the Taxation Commissioner’s decision and thereby remitted all penalties in favour of the taxpayers (the applicants, a couple) but otherwise affirmed the Commissioner’s decisions to assess the applicants’ taxable income for illegal early withdrawal of their superannuation.
The Decision has a useful list of cases and analysis in relation to superannuation taxpayer penalties and the application of the ATO’s regulatory guidance in PS LA 2021/D3 on illegal superannuation withdrawals and PS LA 2020/3 on self-managed superannuation fund administrative penalties, which as shown below were given minimal weighting by the Tribunal in making its Decision.
Background
The applicants were a couple, one a retail worker and one a teacher, who were developing two townhouses in 2018.
Their builder went into liquidation causing around a $300,000 loss to the applicants plus additional costs.
The couple sought additional funding to complete the townhouses to recover their losses but were unsuccessful.
Their broker referred them to a tax agent “Mr W” (who was later deregistered by the TPB in 2022).
Mr W encouraged the couple to set up a SMSF and roll over their superannuation from Mercer and VicSuper into their new SMSF to use the funds to complete the development. The couple would withdraw $380,000 in aggregate.
The couple refused to pay Mr W’s fees (which they described as “commision”) of $10,000 and Mr W terminated their relationship before completing the superannuation rollovers.
The couple engaged a new tax agent, replacing Mr W, in around April 2019 and conducted the rollovers of their $380,000 in superannuation into their SMSF after having engaged their new tax agent.
The couple conducted their superannuation withdrawals into their SMSF in nine transactions, which they did not tell their new tax agent about.
No tax returns were filed for the SMSF and the applicants each filed their income tax returns without including amounts withdrawn from the SMSF. The Commissioner wrote to them in December 2020 requesting the outstanding SMSF tax returns.
The first applicant called the Commissioner to cancel the SMSF’s ABN and advise that the SMSF was not legally established because it had no assets. He claimed that Mr W advised him to do this. It was found that the first applicant’s phone call with the Commissioner contained misleading statements from the first applicant, which affected his credibility before the Tribunal.
Section 304-10 and PS LA 2021/D3
Section 304-10 of the Income Tax Assessment Act 1997 (ITAA 97) was invoked due to the applicants’ withdrawal of superannuation from their SMSF before they had retired or otherwise met a condition of release (the author calls the “breach”), which would have otherwise allowed them to withdraw their superannuation.
A result of the breach was that an amount calculated with regards to the superannuation withdrawal amount would be included in their assessable income under section 304-10.
The breach itself having been committed was not disputed by the applicants. Rather they sought an exercise of discretion under section 304-10(4) that it would be unreasonable for the amount calculated under section 304-10 to be included in each applicant’s assessable income.
The meaning of “unreasonable” was noted with agreement from the Tribunal in the case of Mason v Federal Commissioner of Taxation [2012] AATA 133 (bold emphasis added):
Meaning of “unreasonable”
Having regard to the above legislative history and context of section 304-10(4) of the ITAA 1997, […], the Tribunal considers that it may be “unreasonable” to include a superannuation benefit paid in breach of the legislative requirements in a persons’ assessable income (with the result that it is taxed at marginal tax rates) in circumstances where, for example:
(i) This would be in addition to other taxation consequences which flow from the breach. […]; and/or
(ii) The benefit arose in circumstances beyond the effective control of the recipient.
[32] However, it will not be “unreasonable” to include a superannuation benefit in a person’s assessable income (to be taxed at marginal tax rates) merely because the taxation consequence prescribed by Parliament is difficult for the taxpayer to meet, or is regarded by the taxpayer as undesirable. If this were so, the important deterrent effect of section 304-10 of the ITAA 1997 would be undermined and an unintended taxation benefit would thereby be conferred on the recipient of the payment.
It was a claimed lack of “effective control” by the applicants which formed the key part of their argument that the discretion should be exercised in their favour due to their circumstances.
However, the type of lack of control claimed (e.g. referring to Wainwright v Federal Commissioner of Taxation [2019] AATA 333) was corrected by the Tribunal as being a reference to the carrying out of the actual breach transaction being outside of the applicants’ control, not a lack of control over what led to the financial hardship that the applicants sought to alleviate by entering into the breach transaction (the latter being claimed by the applicants in relation to the builder’s liquidation losses).
The applicants knowingly conducted the nine superannuation withdrawals, this was not outside of their control.
The Australian Taxation Office (ATO) Practice Statement Law Administration PS LA 2021/D3 was referred to because it is self-described as “explain[ing] when and how to exercise the discretion in subsection 304-10(4) of the [ITAA 97] where a member receives superannuation benefits in breach of legislative requirements” and it discusses effective control in its appendix 1.
However, the Tribunal considered PS LA 2021/D3, stating:
it is hard to understand why draft rulings hang about in draft form for years, although I do not take the same view that this factor alone makes PS LA 2021/D3 of reduced relevance. As an aside, the Tribunal wonders how hard it can be to finalise something that has already been written, and how much time is needed to consider submissions and comments received. While the Commissioner has a complex and enormous job, four years have passed since PS LA 2021/D3 was first issued. Of course, in the taxation field we continue to deal with two income tax acts in the ITAA 1997 and the ITAA 1936 about 30 years after a rewrite process commenced.
And the Tribunal stated it approached its decision by considering the legislation, regulations, and the case law, and not by applying PS LA 2021/D3.
With the effective control argument having failed, this left the applicants’ claims of reliance on advice from Mr W at the heart of their case for an exercise of discretion not to include the superannuation withdrawals in their assessable income.
Decision
The applicants’ other broad primary argument included that they were “everyday Australians” who relied on erroneous or misleading advice of Mr W, which “led [them] astray” to illegally withdraw their superannuation via a SMSF where they had not retired or satisfied any other condition of release.
Note that it was not pursued in the Tribunal’s Decision whether the course of Mr W’s advice to the applicants (which as addressed below was largely abandoned or ignored) could have been proceeding towards considering a potential structure of investment by the SMSF (rather than an outright withdrawal that the applicants did) into the failed townhouse development that could have avoided being an in-house asset or prohibited member benefit/loan (if that was even possible in their circumstances given the development was owned by the applicants in their own names in partnership with their children) or causing some other superannuation compliance breach. The applicants would exit the SMSF environment permanently following the Tribunal Decision.
The applicants could not articulate properly what Mr W’s advice was (there was no written advice) nor did they pursue any claim of negligence against Mr W. Mr W was not called to give evidence at the Tribunal. The applicants were provided with materials from Mr W before termination of his engagement, which the Tribunal referred to (emphasis unchanged):
The article the Applicants were provided by Mr W should have put the Applicants on notice, and they had more than enough time to read it and consider it before taking the steps they did. They still have not read that article which is 6 pages long. The article specifically states that “[a] superannuation fund is prohibited from providing non-retirement benefits to members and related parties.” That is quite clear and uses plain English. What the Applicants were doing was not allowed. Page 2 of the article specifies that property developers need to be unrelated to the SMSF. The Applicants were related to the SMSF. Even the mere title of the article “Can a SMSF invest in property development?” could have led the Applicants to ask “how is the SMSF investing? Aren’t we the ones withdrawing and then putting the funds into the development? What is the SMSF doing?” The first Applicant did not strike the Tribunal as being unable to understand basic matters. The second Applicant is a teaching professional so in principle, given her training, the Tribunal does not believe she would be unable to think of basic questions such as that.
Other factors in the applicants’ circumstances were considered but the Tribunal concluded on balance that it was not satisfied that inclusion of the superannuation withdrawals in the applicants’ assessable income was unreasonable as: “[t]he Applicants might well find those consequences “crushing,” but those consequences were intended to apply to taxpayers that do what the Applicants did.”
Remission of penalties
The Tribunal showed much empathy with the applicants’ circumstances. The Commissioner argued that the applicants had already received a substantial penalty remission (down to $4,200 for each applicant) and stated:
[T]he penalties should not be further remitted as the penalty consequences “flow naturally from the law as provided by Parliament and applied to the Applicants’ own conduct” and because they breached the law, did not report what they had done “and did all of this in ignorance or negligence of their lawful obligations as directors of the Trustee”.
But the Tribunal disagreed with the Commissioner’s application of its own PS LA 2020/3 stating (emphasis unchanged):
I also record I have considered the Commissioner’s policy Practice Statement Law Administration PS LA 2020/3 Self-managed superannuation funds — administrative penalties imposed under subsection 166(1) of the Superannuation Industry (Supervision) Act 1993 (“PS LA 2020/3”). This is on the same basis as I have taken into account PS LA 2021/D3 and is as described above.
[…]
While I agree the purpose of the penalty regime and the seriousness of breaches are factors to consider, and while I accept that the Commissioner has already substantially remitted the penalties originally imposed at audit, I do not believe that PS LA 2020/3 appropriately weighs the significance of the other taxation consequences on taxpayers when considering remission in this context.
The Tribunal stated its view that the applicants would likely never commit such a breach again (having exited the SMSF environment and been disqualified from acting as corporate trustee directors or trustees of a SMSF) and that the consequences of this case were significant enough on the applicants that their penalties should be remitted in full.
