Dealing with ATO rectification directions
Receiving an ATO rectification direction for a compliance breach may seem like winning at the casino, especially when the alternative is a trustee disqualification or non-compliance.
But dealing correctly with an ATO rectification direction can mean the difference between the ATO issuing further penalties or a notice of non-compliance.
The release of a new practice statement PSLA 2023/1 demonstrates that the ATO expects SMSF trustees to take rectification directions seriously and implement its compliance treatment within a defined time frame.
A rectification direction is applied under s159 of the Superannuation Industry (Supervision) Act 1993 (SIS Act) and comes with various conditions. PSLA 2023/1 sets out the guidelines for ATO staff in determining what is required to give a trustee or director of a corporate trustee a rectification direction.
What is a rectification direction?
A rectification direction is a written direction from the Commissioner that requires a person to take specified action to rectify the contravention and then provide the ATO with evidence they complied with that direction.
The ATO will issue a rectification direction depending on changes in the superannuation laws, the level of non-compliance, and its enforcement activities.
The primary outcome is that there are no further contraventions of a similar kind, which can also mean putting managerial or administrative arrangements or corrective action in place.
Rectification can include taking specific steps such as repaying a loan or borrowing, disposing of an asset or lodging a return.
The ATO can also implement other compliance options with a rectification direction, such as giving an education direction and charging administrative penalties.
A consideration of all the facts and circumstances is necessary before the ATO issues a rectification direction, including:
- The extent of the financial detriment experienced by the fund to comply
- The nature and seriousness of the contravention
- Any other relevant circumstances
The weight given to each factor depends on whether the fund will be worse off financially, the number and severity of the contravention/s, the trustee’s behaviour and history, the value of the assets involved and the trustee’s actions.
What is certain is that a rectification direction cannot be applied where the ATO disqualifies an SMSF trustee, issues a notice of non-compliance or takes action to wind up the fund.
It also extends to when the ATO accepts an enforceable undertaking where it is not withdrawn or amended and no longer covers the actual breach.
How is a rectification direction issued?
A rectification direction can only be issued where ATO staff reasonably believes that a person has contravened a provision of SIS or an SMSF auditor lodges an auditor contravention report (“ACR”).
Where the ATO only has mere suspicion that a contravention has occurred will be insufficient grounds to issue a written direction. Further investigation is required to conclude that a contravention has occurred.
Interestingly, s129 of the SIS Act requires SMSF auditors to report a contravention of SIS where a contravention may have occurred, may be occurring, or may occur concerning the SMSF.
Whether the ATO can issue a rectification direction because a contravention may occur, as reported by an SMSF auditor, is unclear.
It may be in the best interests of SMSF trustees for the ATO to provide further clarification to ensure it continues to operate within its guidelines.
Time frame to comply
The rectification direction must specify the period that the trustee must comply with. The ATO has stated that the time frame must be reasonable and that, generally, a period of up to six months will be sufficient.
In extreme cases, it may take up to 12 months to comply. Still, if the given period is not reasonable, the ATO can vary the direction on its own initiative or upon request by the person given the direction.
The ATO cannot impose an administrative penalty for failure to comply with a rectification direction but will consider other compliance actions, including firmer ones.
However, failure to comply with a rectification direction within the specified period carries a maximum of 10 penalty units currently worth $2,750.
Example 1 – enforceable undertaking given over rectification direction
An SMSF established eight years ago loaned money to a related company and exceeded the 5 per cent in-house asset limit.
The ATO reviewed the fund and noted that the trustees had not divested the in-house asset even though a written plan was in place.
The trustees presented a written undertaking to follow the plan within three months. The ATO accepts the enforceable undertaking because the fund will not be worse off, the trustees have a good compliance history, and the revised time frame is reasonable.
Conversely, if the proposed undertaking time frame had been too long, the ATO would have issued a rectification direction with a shorter period.
The following examples demonstrate how the ATO deal with trustees when issuing a rectification direction.
Example – rectification direction given
An SMSF established three years ago borrowed money from a member to finance the acquisition of a residential property because it did not have the deposit. The SMSF auditor lodged an ACR, and the ATO audited the fund.
The trustee did not want to sell the property as the market was weak, and the fund would lose on the sale. The ATO considers the contravention severe even though the fund will experience financial detriment by unwinding the arrangement. It acknowledges the trustee is inexperienced and failed to obtain advice before the purchase.
The trustees receive a rectification direction and must dispose of the property within three months, in line with the ATOs general decision-making principles.
Example 3 – notice of non-compliance issued
An SMSF established three years ago failed to lodge annual returns since inception despite ongoing ATO communication. The SMSF auditor lodges ACRs for multiple breaches over those years.
The ATO’s audit shows that besides non-lodgement, the fund has no investment strategy, no records of financial transactions and a substantial amount of money loaned to a member.
The facts and circumstances are serious as the trustees put fund assets at risk and ignored requests to lodge on time. The ATO issued a notice of non-compliance.
The ATO has issued PSLA 2023/1, demonstrating the importance of complying with rectification directions.
Understanding how the ATO deals with rectification directions will reduce further penalties and stop non-compliance notifications.
While not complying with a rectification direction cannot result in the ATO applying penalties, failure to meet the deadline to comply will.
The best action for SMSF trustees and their advisers is to be proactive and rectify a contravention before the ATO investigates. The alternative is always more painful.