When an SMSF member becomes disqualified

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The impact of a trustee/member of an SMSF becoming bankrupt is significant for the individual, the SMSF and other members of the fund, yet little is generally understood about this unfortunately common occurrence. When bankruptcy occurs, the focus centres on the personal assets of the individual who has become bankrupt, their business assets and structures they control or have an interest in, while the impact on their SMSF is often ignored.

So what is the effect of an SMSF trustee becoming personally bankrupt?

Bankruptcy and the superannuation legislation

When a trustee/member of an SMSF becomes bankrupt, they fall under the provisions covering ‘disqualified persons’ in the Superannuation Industry (Supervision) Act (the SIS Act). A person is a disqualified person if they are an undischarged bankrupt, that is, insolvent under administration.

This has particularly serious consequences for the bankrupt individual and action must be taken as soon as the issue is identified.

This is because the individual commits an offence if they act as trustee of their SMSF knowing they are a disqualified person, and a failure to resign immediately as a trustee of the SMSF exposes them to penalties that range from the most serious, being two years’ imprisonment, to a strict liability offence, or ‘on the spot fine’ of 60 penalty units, currently worth $10,800.

What happens to their SMSF?

While an individual bankrupt must resign as trustee, they do not immediately need to cease to be a member of their SMSF. By resigning as trustee, their SMSF will no longer technically satisfy the definition of an SMSF for the SIS Act. However, that definition gives such an SMSF a period of six months where it is deemed to satisfy the definition.

During this six months, the bankrupt individual and any other trustees must address the trustee structure of the SMSF and bring it back in line with the definition. This is most obviously achieved by the bankrupt individual rolling over their SMSF money into another superannuation arrangement where they do not have any obligations to act as trustee.

Can someone act as trustee on behalf of the individual bankrupt?

The SIS Act envisages that someone other than the member can act in that member’s place as trustee in specific circumstances. So, for example, a parent or guardian can act as trustee in the place of a child (who is under a legal disability). A person who has been granted and accepted an Enduring Power of Attorney (EPOA) by a member of an SMSF can act in the place of that member, for example, where they have lost capacity due to illness or old age.

However, the SIS Act is equally prescriptive when it comes to members who are disqualified. The legislation specifically prohibits a person with an EPOA of the disqualified person acting as trustee of the SMSF on behalf of that person.

The bankrupt individual has no option but to remove themselves as a member of their SMSF within the six-month period.

When does the six months start?

The SIS Act sets out that the six-month grace period, where the SMSF is deemed not to fail the definition of an SMSF, starts from the time it no longer satisfies the definition and so would otherwise cease to be an SMSF.

In these circumstances, this would be from the time the bankrupt individual resigns as trustee of their SMSF. At this time, they are still a member of their SMSF but are no longer a trustee.

Can anyone else be treated as a disqualified person?

There is a range of other circumstances which spell the end of an individual’s involvement with their SMSF, regardless of whether the person is an individual trustee or a director of a corporate trustee.

Indeed, the problems for other members of an SMSF are even worse for an SMSF with a corporate trustee, as any director who is individually found to be a disqualified person and so is ineligible to continue as a director of the corporate trustee, also taints the corporate trustee. Under the definition of a disqualified person, the corporate trustee itself becomes a disqualified person, even where the majority of directors are not disqualified persons.

A change in the trustee structure is forced upon the whole SMSF because of the disqualification of only one director. The disqualified person must cease to act as director of the corporate trustee immediately.

In addition to an undischarged bankrupt, a disqualified person in the case of an individual includes where:

  1. A person has been convicted of an offence of dishonest conduct
  2. A civil penalty order has been made in relation to the person under the SIS Act, or
  3. The Commissioner of Taxation has made an order that the individual is not a fit and proper person to be a trustee of an SMSF.

A disqualified person in the case of a corporate trustee includes a company where:

  1. A responsible officer (including a director) of the corporate trustee is a disqualified person
  2. A receiver has been appointed in respect of property owned by the company
  3. A provisional liquidator has been appointed in respect of the company, or
  4. It has begun to be wound up.

A disqualified person must notify the Commissioner of Taxation immediately and in writing that they are a disqualified person. Failure to do so can result in an additional fine of 50 penalty units, currently $9,000.

Fixing up the trustee structure

Apart from removing the disqualified person from acting as an individual trustee or as a director of a corporate trustee, and also removing them as members of the SMSF within the six-month window, there are limited options available to a disqualified person to remedy or have their disqualified status waived.

A person who is a disqualified person due to an earlier conviction for dishonest conduct can apply to the Commissioner of Taxation to have their disqualified status waived in particular circumstances. The Commissioner will consider where the offence is of a less serious nature involving a custodial sentence of less than two years’ imprisonment or a fine of less than 120 penalty units (currently $21,600), the length of time since the offence occurred and the age of the applicant at the time.

There is, however, no opportunity to waive the disqualified status in circumstances where the person is an undischarged bankrupt or has had a civil penalty order made against them under the SIS Act.

Equally, a company which has had a receiver or liquidator appointed or has began to be wound up has no opportunity to remedy that situation other than to be removed as trustee of the SMSF.

Once a person is a discharged bankrupt and so is no longer insolvent under administration, they are free to again act as an individual trustee or director of a corporate trustee of an SMSF.

Bankruptcy of an SMSF member must be addressed

A member of an SMSF cannot ignore becoming a disqualified person, and they must act to avoid a custodial sentence or fine. With only limited options to address the situation, the best course of action is to resign immediately as trustee or director and roll over to alternative superannuation arrangements which do not involve any trustee obligations.

 

Peter Hogan is Head of Technical at the peak industry body, the SMSF Association. This article is general information and does not consider the specific circumstances of any individual.

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