SMSF auditors challenged by new penalty regime
SMSF auditors have been handed a small, but significant, shift in their responsibility as SMSF gatekeepers by the release of Practice Statement Law Administration 2020/3 (PSLA).
The PSLA guides ATO staff on how to apply administrative penalties, which will see SMSF auditors with even the broadest of shoulders challenged on several fronts by this new SMSF penalty regime.
The focus of the PSLA rests squarely on s166 SIS, which sets out the general rules for the imposition of administrative penalties.
When a trustee contravenes a breach of SIS listed in s166 SIS, the law automatically imposes an administrative penalty and the new PSLA gives the ATO a clear pathway to determine whether remission is possible.
The introduction of administrative penalties dates back to 2014, at which time the ATO adopted a softly-softly approach by remitting SMSF penalties and issuing educational directives.
Since then, the number of auditor contravention reports has remained relatively stable at 2% of SMSFs, and trustee behaviour had not changed.
Let's be clear on one thing: the legislation has also not changed.
The ATO has finally decided to enforce it, which is in line with the same approach they have taken with the recently updated SMSF auditor independence guidelines.
What is a Penalty Worth?
With each penalty unit worth $222 in the 2021 financial year, there are hefty fines up for grabs.
s65 SIS (loans to members) accounts for 20% of all contraventions which is an appalling indictment on trustee behaviour and, at 60 penalty units per breach, leads to a whopping $13,320 penalty.
The trustees cannot use SMSF resources to pay the penalty, and it applies separately to each individual trustee or collectively to the directors of the corporate trustee.
Yet the most compelling reason to have a corporate trustee to date.
A breach of s65 SIS finds a corporate trustee receiving one penalty (as it is one trustee = $13,320) as opposed to all individual trustees receiving a penalty separately (a maximum of 4 x $13,320 = $53,230).
The introduction of six-member funds will have an additional impact on individual SMSF trustees where an SMSF penalty is applied, with the kids wondering why they ever joined mum and dad's fund in the first place.
Other Compliance Treatments
The ATO can apply other compliance treatments such as an enforceable undertaking or an education or rectification direction in conjunction with the administrative penalty. They also have the power to partially, fully or not remit the penalty depending on the circumstances of each case.
The PSLA identifies the factors that determine whether remission is appropriate or which may change the extent of a penalty, including:
- The purpose of the penalty provision
- Trustee behaviour and circumstances
- The seriousness of the contravention
- To what extent were fund assets affected?
- Over what period did the contraventions occur?
- Unintended or unjust results
Most importantly, multiple breaches may result in numerous administrative penalties applied.
Where one non-compliant event develops into several contravening provisions of SIS, the ATO would generally remint to a level reflecting the primary contravention.
While that may not appear to be overly generous in light of the ATO's past SMSF penalty remittance history, any penalty reduction is dependant on the factors listed above and whether the cumulative penalty is defensible, proper and just, having regard to the overall circumstances of the case.
SMSF Auditor Independence
SMSF auditors should be on full alert as they will need to ensure they are reporting all contraventions correctly to minimise risk.
In some cases, SMSF auditors may find themselves facing push back from clients about reporting any contravention as required under their professional obligations.
The new independence guidelines outline the situation where actual or perceived pressure from a client deters an SMSF auditor from acting objectively.
The guide states that where the auditor may not be able to eliminate the circumstances creating the threats to independence, they should look to decline or end the engagement.
The ATO will have no hesitation in referring an SMSF auditor to ASIC where they fail to report a contravention as a result of an independence threat.
SMSF auditors may also feel coerced into changing their ACR by substituting a contravention not listed in s166 SIS.
By way of example, rather than reporting a breach of s65 (financial assistance to members) where the members take out $50,000 from their fund, SMSF auditors might be requested to report a contravention of r6.17 SISR instead.
The mindset here is that reporting the contravention in this way negates the automatic application of 60 penalty units, as s166 SIS does not explicitly list r6.17 SISR.
But using that approach is both limited and technically incorrect.
Section 31 SIS sets out the prescribed operating standards under which SMSF trustees must comply, and paragraph (h) of these standards involve the payment of benefits.
Section 34 SIS then says that the prescribed operating standards must be complied with at all times and s166 SISA imposes an administrative penalty for breaching those standards.
Pressuring the SMSF auditor into circumventing a penalty by reporting the contravention under r6.17 is redundant because the operating standards also apply to r6.17.
As a result, the illegal early access means that two (2) separate penalties will most likely apply: firstly, a breach of s34(1) SIS worth 20 penalty units; and a breach of 65 SIS worth 60 penalty units.
Because multiple penalties arose under different provisions of SIS, the primary contravention occurred under s34(1) SIS, which is the payment of benefits where a condition of release has not been met.
Using the PSLA principles, the ATO would generally remit the secondary penalty and reduce the total penalty by 60 penalty units down to 20 penalty units, or $4,440.
Remember, too, that any ATO penalty remission decisions are looked at on a case by case basis for each trustee incurring a penalty.
SMSF auditors and advisers should be aware that the PSLA is all-encompassing. There is no get-out-of-jail-free card for a breach of any reportable section or regulation of SIS, regardless of whether it is listed in s166 SIS or not.
SMSF trustees have been facing a harsher penalty regime for some time, and it should come as no surprise to anyone the SMSF industry that a new administrative penalty paradigm has finally arrived.
We have more certainty around the expectation of how ATO staff will deal with a contravention and the application of SMSF administrative penalties.
There's no doubt that with auditors the last step before the ATO in the SMSF foodchain, they are going to be challenged in this new SMSF penalty regime.
Shelley Banton, head of education, ASF Audits