The Federal Court has recently examined when property is held by a regulated superannuation fund and thus exempt from being available to a trustee in bankruptcy. This is only part of the story, though. Bankruptcy also puts at risk the concessional taxation treatment of superannuation fund income and the ability for a fund to remain self-managed.
Part 1 of this post began with the statement that self-managed superannuation funds are common but not always administered well.
Importance of being a compliant fund
Income of a compliant fund attracts concessional taxation treatment. This makes superannuation attractive compared with other investments.
The bankruptcy of a trustee or director of a corporate trustee of an SMSF puts compliant status at serious risk.
Bankruptcy and compliant status
The Superannuation Industry (Supervision) Act 1993) (“SIS Act”) s 45 provides that a fund is compliant if the Regulator (for SMSFs, the Commissioner of Taxation) either has given a notice to a trustee of the fund stating the fund is a complying fund for that year or gave a notice for a previous year of income and has not given a notice that the fund was not complying for the current year or any year after the complying notice was issued.
A fund will be a complying fund if no trustee of the fund contravened any of the regulatory provisions applying to the fund in respect of the relevant year of income. “Regulatory provisions” include the SIS Act itself, though s 39 provides that non-compliance with the SIS Act will only be a contravention for determining compliance where the conduct amounts to an offence or contravention of a civil penalty provision.
The SIS Act s126K provides that it is an offence if a disqualified person, with knowledge he or she is disqualified, acts as a trustee of a regulated fund.
Disqualification occurs through s 120(1)(b) which provides that an individual purporting to act as trustee will be a disqualified person if they are an insolvent under administration. This takes in both an undischarged bankrupt and someone who has entered a personal insolvency agreement.
In the case of corporate trustees s 120(2) provides that a body corporate is a disqualified person if it has reasonable grounds to suspect that a person who is, or is acting as, a responsible officer of the body corporate is a disqualified person.
These provisions mean that if a person who is a director of a corporate trustee of an SMSF becomes bankrupt both he or she and also the trustee itself will usually be disqualified from acting as trustee and potentially at risk of prosecution pursuant to the SIS Act s 126K.
SMSFs have a less stringent regulatory regime than other funds. Bankruptcy will affect the SMSF status given that the SIS Act s 17A(1)(d) requires that each member of a fund having a corporate trustee must be a director of that trustee and bankruptcy usually disqualifies a person from managing a company.
Notably, the SIS Act s 17A(4) provides a six month “grace period” before SMSF status is lost.
Potential for waiver
The effect of disqualification on the grounds of bankruptcy cannot be waived by the Commissioner of Taxation.
A bankrupt who is trustee, or director of a trustee, of an SMSF however can seek leave from the Court to continue acting as the trustee, or director of a corporate trustee under the SIS Act s 126J. For a corporate trustee the person must also obtain leave pursuant to the Corporations Act 2001 s 206G and will then need to seek re-appointment as a director to satisfy the obligation in the SIS Act s 17A(1)(d).
While there are few reported cases on the section, it is fair to say that the Courts will not treat the powers in the SIS Act s 126J and the Corporations Act s 206G as a mandate to allow a return to “business as usual” by a bankrupt trustee or director of a trustee of an SMSF.
Rather, these powers will more likely be used to allow a bankrupt time to “put their house in order”, meaning that any orders made may be conditional as to both the time they remain in place and the functions the bankrupt may exercise.
Remedies and conclusion
If leave is granted for an interim period, then a trustee, or director of a corporate trustee, of an SMSF may take steps to seek the annulment of his or her bankruptcy under the Bankruptcy Act 1966 ss 153A or 153B.
Another option if bankruptcy cannot be avoided or annulled, depending on the assets in the fund and timing, is to move the member’s interest in the fund into what is known as a small APRA fund, though this typically involves higher fees than an SMSF.
Naturally, the best way for a person to avoid any of the problems discussed in these posts is to avoid becoming bankrupt to begin with. Even upon on the cusp of, or following, bankruptcy commencing a person with a regulated fund does have options for preserving their SMSF and membership interest.
Cowell Clarke are experts in advising upon both bankruptcy and the re-structuring of superannuation funds
This publication has been prepared for general guidance on matters of interest only and does not constitute professional legal advice. You should not act upon the information contained in this publication without obtaining specific professional legal advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication and to the extent permitted by law, Cowell Clarke does not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting or refraining to act in relation on the information contained in this publication or for any decision based on it.