Loaning money in a self managed super fund to the spouse of your sister, who then loans this money to your business, is likely to lead to trouble.

This is one key lesson from a Federal Court case handed down in December 2014 involving Anthony Lyons. The other key lesson is that a few days can make a substantial difference to the penalties you might face if the ATO takes action against your super fund.

The details

The Lyons Family Superannuation Fund was set up in June 2008. It had two members, Anthony and his former wife Julianne. The fund was capitalised in July 2008 with almost $200,000 in transfers from the Queensland Government Employees super fund (Q Super) and another employer-sponsored super fund.

Between July 2008 and May 2009, the fund loaned $190,000 to Paul Ellis, the spouse of Anthony Lyon’s sister. Under the super laws, Mr Ellis is deemed to be a relative of Mr Lyon.

Mr Ellis then loaned this money to the Lyons’ struggling business. It appears that this money was lost because the business failed in March 2010. Its failure also pushed the Lyons into bankruptcy.

This rather unusual loan process was suggested to the Lyons by a financial adviser. The adviser is said to have suggested that the loan from the trustee to Ellis should be documented as a “Debtors Factoring Agreement” so the true purpose of the loans was disguised. None of this information appears to have been tested in court.

Auditor’s report

The fund’s external auditor, as required by the super laws, told the ATO about the loans and that, in his opinion, they were a breach of various super laws. In particular the following problems identified were:

• Sole purpose test – a fund must be run to satisfy certain statutory purposes and the loans breached this requirement.
• In house assets: the loans to Ellis were to a fund member’s relative and as such these loans are deemed to be in-house assets. The maximum in-house assets allowed is 5% of the fund’s total assets using a prevailing market value for all super fund assets. The Lyons had loaned Ellis over 97% of the fund’s assets – a clear breach. When this 5% is exceeded, a super fund’s trustee has to prepare a written plan within a specific timeframe about how they will bring the fund back into compliance with this requirement. Once this document has been prepared, the trustee has until the end of the next financial year to implement it. Super law breaches arise for not preparing the written plan or implementing it in the required timeframe. None of this rectification process had been conducted.
• Arm’s length dealing: the loans were made in the full expectation that they were never going to be repaid. Ordinarily, the arm’s length rule demands that the other party to a transaction must not obtain any monetary benefit greater than that which would ordinarily be available when two parties are operating at arm’s length.

The ATO then looked at the super fund and its records and, after interviewing Anthony Lyons on three separate occasions, came to the same conclusion as the external auditor.

The ATO’s reaction

The Tax Office’s first action was to make the fund non-complying in the 2009 financial year. In the year a super fund is deemed to be non-complying, the tax rate is 45% and charged on the market value of the net assets of the fund, less non-concessional contributions at the start of the financial year. At the time, the fund had assets of less than $2,500.

If the transfers from the corporate super funds had occurred just before the end of the financial year, several days earlier in 2008, then the fines would have been significantly higher. It’s amazing the difference a few days can make!

As the ATO had declared the fund to be non-complying, it was unable to apply tax penalties on the illegal withdrawal of money from a super fund.

The ATO’s next step was to seek Court imposed fines against the Lyons as super fund trustees. Before the Court hearing, the ATO and the Lyons had agreed that they would jointly propose that only Mr Lyons should be penalised because he was primarily responsible for the fund not complying with the super laws.

However, the ATO told the Court that Lyons had fully co-operated with the ATO’s investigation and had made full admissions and this should be considered in the penalties imposed by the Court.

The Court accepted this view and imposed a modest fine of $37,500, which included a small amount for the Tax Office’s legal costs.

Under rules put in place from 1 July 2014, the ATO would have been able to impose other, overall much higher, specific penalties for breaching the three specific super laws mentioned above.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.