By Daniel Soire
Many individuals, in particular business owners, are now choosing to control the destiny of their superannuation through the use a Self Managed Superannuation Fund (“SMSF”). The Australian Taxation Office (“ATO”) statistics suggest that there are now more than 500,000 SMSF’s in operation. It is likely that this number will continue to increase and that from time to time a SMSF may find itself in the position of having a bankrupt member and therefore possibly having to be wound up.
The winding up of a SMSF can quite often result from the bankruptcy of one of its members. There is more information on the ATO website about how to wind up an SMSF. Just go www.ato.gov.au/Super/Self-managed-super-funds/Winding-up/
SMSF’s are managed by either a corporate trustee or each member of the fund as trustees. In this article, we assume (as is most often the case) that the trustee is a corporate trustee. Certainly from Government commentary of late it appears to be that they may look at legislating that all SMSF’s must have a corporate trustee (with potentially some grandfathering provisions in the near future). We note that presently the Superannuation Industry (Supervision) Act 1993 (“SIS Act”) requires that all members of the SMSF be directors of that corporate trustee.
- So what happens when a member of the SMSF becomes bankrupt?
When a member of the SMSF becomes bankrupt or enters into a personal insolvency agreement (“PIA”) with their creditors as an alternative to bankruptcy, then that member becomes a “disqualified person” in accordance with the Section 120(1)(b) of the SIS Act. Further, the Corporations Act says that when an individual becomes bankrupt, “they are prohibited” from acting as a director of a company. This means that the member cannot take part in the management of the SMSF. When this happens, the trustees are required to notify the ATO immediately in writing. Failure to do so is an offence.
The above issue CANNOT be overcome by appointing someone prior to the bankruptcy event as their enduring attorney as is frequently suggested – based on Section 17A of the SIS Act this is ineffective.
Such provisions mean that SME business owners need to consistently review whether their SMSF needs to be restructured and then possibly wound up. This is particularly important where the SME may be facing financial difficulty and the business owner/s (for example husband and wife) may ultimately end up in bankruptcy (and accordingly they become a disqualified person).The typical SMSF (consisting of the husband and wife) the fund will need to be restructured if bankruptcy occurred or control of the SMSF may revert to an small APRA fund or alternatively the assets realised and rolled over into a retail fund and then the SMSF can be wound up.
- But what if there is a non-bankrupt member – options available for them!
Members of a SMSF are permitted under the SIS Act a grace period of six (6) months from the date of bankruptcy in which to restructure the fund. Possible options for members to consider with input from their professional advisors could include:
1. IF the SMSF’s Assets are significant or lumpy (ie commercial property which may take many months to realise for a fair price) or may give rise to significant CGT issues then consider converting same into a small APRA fund (“SAF”) whereby an “approved trustee company” can be appointed to manage same. In this case, a bankrupt and even the non-bankrupt member can continue to be members of the SAF. An approved trustee company’s costs will vary depending on the specifics of the SMSF assets, but we understand range from around $5,000 upwards.
2.Rolling out the bankrupt member’s account balance to an externally managed retail fund. Obviously this would involve realisation of certain assets of the SMSF to facilitate the rollover and timing and CGT considerations would need to be given. This would leave the non-bankrupt member to operate the SMSF solely.
3.However in analysing point 2 above, it is relevant to also consider whether there may have been any breaches of the SMSF. We often see that SMSF’s are in breach of the in-house asset rules whereby they have lent money to a related business which ultimately is not recoverable because it is had to go into external administration. In instances such as this, point 2 may not be appropriate. It may be more appropriate to consider rolling out member account balances to an externally managed retail fund and then winding up the SMSF.
So in short, where an SME is in financial difficulty and may end up in some form of external administration with the flow-on effect to directors via personal guarantees, a review and discussion of the implications on the SMSF and non-bankrupt member funds should occur with the individuals and their professional advisor. Don’t leave it too late!!!
However Reminder: ALSO BE aware of the claw back provisions
In previous communications we considered in detail the various provisions within the Bankruptcy Act (“the Act”) that deal with a bankrupt’s interest in a superannuation fund. Section 116(2)(d) of the Act says that an interest in a regulated superannuation fund is not divisible property. However, Section 128B of the Act provides that a transfer (i.e. a payment) made by way of a contribution to an eligible superannuation fund with the purpose of that property then not being available to creditors is void against a Bankruptcy Trustee. This occurs for transfers on or after 28 July 2006 and includes transfers made to a SMSF.
In determining whether the person had the requisite purpose in making the contribution, the Bankruptcy Trustee will typically consider the individual’s pattern of contributions and whether the contribution in question is “out of character”. It is not always the case that an out of character contribution will automatically be void, rather, an out of character contribution may indicate that the transferor was aware of their financial problems and as a result would be required to explain the purpose of the contribution to a Bankruptcy Trustee.
Let’s consider the example of an individual who withdraws $50,000 from their SMSF to fund working capital in a business interest. Let’s assume that the business interest fails and shortly prior to bankruptcy, the individual, in an effort to repay the $50,000 to the SMSF, makes a transfer to the SMSF (either cash or some other asset). A Bankruptcy Trustee may view this transfer as out of character and made at a time when the individual was insolvent and seek to recover the amount.
Whether a particular strategy is right for you (and the other members) depends on the circumstances of the SMSF. Accordingly, it is important that members of SMSF’s facing financial difficulties (and ultimately bankruptcy) get the right professional advice at the earliest possible time.