Dealing with common and major contraventions

BDO’s superannuation partner, Shirley Schaefer, provides a detailed account of the persistent and significant contraventions she encounters in the SMSF audit process, and outlines how to best rectify issues that arise.

The auditor’s main role in SMSF administration is to provide an independent verification of an SMSF’s financial statements and compliance with the SIS legislation. The auditor can also be a crucial link to SMSF trustees and their tax and financial advisers. The SMSF auditor can assist trustees and their advisers when compliance issues arise, and is an important part of the rectification process and communication with the ATO.

Most auditors will go out of their way to assist trustees and their advisers/accountants in relation to SIS compliance and interpretation.

Common contraventions: mistakes

Many SMSFs will no doubt at some point find themselves in a position where they have breached one or more provisions of SIS, and rectification and correction actions are required.

Where genuine mistakes are made by trustees and are rectified in a timely manner, the ATO’s response is usually to reinforce the trustee’s responsibility under the SIS rules, but it is unlikely to take serious action against the trustees or penalise them for their mistakes.

It is important for trustees, accountants and auditors to recognise, that although a contravention may not be significant or even serious, there are still obligations on the SMSF auditor to report the contravention to the ATO and the trustees.

Some of the more common mistakes trustees can make include:

• Using the wrong cheque book (or internet banking) and paying for personal expenses from the SMSF; and 

• Depositing SMSF monies to a personal bank account.

These mistakes are often as a result of perhaps not having SMSF bank accounts clearly identified as for the SMSF. The bank account may just be in the name of the trustees, with no designation that it is held on trust for the SMSF. Clearly identified bank accounts can help trustees ensure that these mistakes are not made.

In some cases, the bank may contribute to mistakes. Perhaps they transferred a term deposit to the wrong bank account on maturity or used the SMSF’s bank account as a mortgage offset account for the trustee’s home loan. Again, having the bank account clearly designated as an SMSF bank account can avoid these mistakes occurring.

Having a corporate trustee of the SMSF can also assist in this area, as it will mean that all SMSF assets should be clearly and separately held on trust for the SMSF.

Common contraventions: significant

The most commonly identified significant contraventions often revolve around related party transactions, principally loans and financial assistance to members and in house assets – loans to, leases to or investments in related parties.

The ATO takes the most interest in those transactions or events where the SMSF appears to be used for any other purpose than the provision of retirement benefits. Of particular concern to the ATO is where SMSF assets have been used to obtain a current day benefit for members or to ‘prop up’ or support other interests of the members, for example a loan to support the cash flow requirements of a failing related party (often the member’s own business).

Where an SMSF has made an investment in an in-house asset that exceeds the 5 per cent permitted threshold, it is important the trustees take the required action:

• Establish a written in-house asset rectification plan;

• The plan must document how the trustees are going to dispose of the excess in-house asset;

• Execute or carry out the plan.

Trustees have until 30 June of the year following the year of contravention to have the plan in place and to have disposed of the excess in-house asset.

Where the in-house asset represents a loan to a member or a related party, the auditor will also need some evidence and information that the trustees have complied with other relevant SIS compliance obligations, e.g.:

• That the terms of the loan are on an arm’s length basis;

• That there is a written loan agreement;

• That interest paid on the loan is commercial (particularly if the loan is unsecured); and

• That the loan has been repaid.

If trustees or their advisers and accountants are unsure of what is required or what might be acceptable to the ATO as a rectification plan, they should consult the SMSF’s auditor for input and assistance.

Rectification of contraventions

It might be a natural reaction to pretend that the contravention did not occur and to not want to deal with more significant issues. However, for the best outcome with the ATO, trustees should always address any contraventions as soon as possible.

The ATO has recently established a SIS compliance voluntary disclosure service, where trustees and their advisers can report compliance issues to the tax office before the auditor lodges a contravention report. The existence of this service does not necessarily mean that the auditor’s role is redundant. It’s more about timely reporting and timely correction and rectification.

Auditors can provide some great advice and assistance to trustees and their advisers of the rectification actions that may be required. The introduction of this service does not replace the auditor’s role in reporting SIS contraventions but enables trustees to stick their hands up and fess up to mistakes and how they are being rectified. This should make the auditors review and audit more straightforward and less risky

Reporting contraventions

SMSF auditors have legislative obligations to report certain contraventions to the ATO, as well as to the trustees of the SMSF. The auditor should be reporting to the ATO as soon as they become aware of the contraventions, but trustees should be addressing these issues much sooner than when the auditor points it out.

The auditor’s obligation to report to the ATO is compulsory in many cases. Commonly, the auditor will be required to report contraventions to the ATO in the following circumstances:

• Where the SMSF fails the definition test;

• Where the SMSF trustees have repeated contraventions or have not rectified contraventions from previous periods;

• Where SIS imposes a statutory time limit and the time limit is breached, e.g. the trustee does not sign the ATO’s trustee declaration within 21 days of being appointed; and

• Where the value of the contraventions represents more than 5 per cent of SMSF assets or the value of the contravention is greater than $30,000.

Where the contravention has been rectified before the auditor has finalised their audit or lodged the contravention report, this can also be reported on the Auditor Contravention Report form (ACR). Including this information on the ACR enables the ATO to more easily and accurately assess the SMSF and the contraventions that have been reported.

After the auditor has submitted their ACR, there is no communication with the auditor by the ATO unless some clarification is required regarding the report that has been lodged. The ATO will communicate with the trustees regarding the outcome of the reported contraventions, however, there is usually no further communication with the auditor. Unless the trustees, administrator or accountant provide information to the auditor, they will not know the outcome of any ATO review. The auditor does have the right to request the information form the trustee, and if a report is made, the auditor should always request the ATO report or review to understand the outcomes, and in particular of any actions required of the trustees by the ATO.

It would be more convenient and could improve the communications and relationship between auditors and the ATO if direct communication was possible, not just from the auditor to the ATO, which is possible, but more importantly, from the ATO to the auditor. It is pleasing to see that the ATO announced last week that they are working on improving the communications with auditors. 

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