The starting point is s126K in the Superannuation (Supervision) Industry Act 1993 (SIS), which says that a person must not act as a trustee of a fund when they know they are a disqualified person. They must resign immediately and cannot have a legal personal representative (LPR) appointed.

The fund then has six months to restructure. How that plays out depends on whether the fund has an individual or a corporate trustee

Disqualified individual SMSF trustees

SIS s120 deals with the definition of a disqualified person for an individual trustee, where disqualification can occur for three reasons:

1. Being convicted of an offence in respect of dishonest conduct, which may include:

• Obtaining a financial advantage by deception (such as dealing dishonestly with the ATO)
• Receiving stolen property or the individual was the one stealing
• Engaging in dishonest behaviour that resulted in a loss (such as being involved with Centrelink fraud)

1. The person receives a civil penalty order, which is typically a monetary fine that could include an unpaid parking fine
2. The person is an undischarged bankrupt under the Bankruptcy Act 1966, which includes a person who has executed a personal insolvency agreement under Part X of the Bankruptcy Act 1966

When a trustee becomes bankrupt, they must inform the ATO in writing immediately.

While a trustee can appeal to have the ATO waive the disqualification if done within 14 days of the conviction, a trustee disqualified due to bankruptcy cannot have it waived.

They can, however, become a trustee again once no longer bankrupt.

Sifting carefully through the issues the trustee faces is essential because, depending on the circumstance, it may not lead to disqualification.

Disqualified corporate SMSF trustee

The requirements to be a director of a corporate trustee falls under s201B of the Corporations Act 2001. They must act with care, diligence and good faith and not be an undischarged bankrupt.

On 1 January 2021, a new amendment introduced to the Corporations Act 2001 affected SMSFs.

A formal debt restructuring process was included for small companies enabling financially distressed but viable businesses to restructure debt so they can continue to trade.

The process is that a restructuring practitioner is appointed to mediate and set up a plan with creditors to repay the debt.

But appointing a restructuring practitioner to a corporate trustee renders it disqualified under s120(2)(ca) of the SIS Act, which was a new provision inserted in the SIS rules in December 2021.

And what this does is reinforce the reason why a fund should have a sole-purpose corporate trustee.

The ATO can also disqualify an individual under SIS s126A if they are satisfied that they are not a fit and proper person or they’ve contravened SIS.

The behaviour has to be severe with repeated breaches for the disqualification to occur, and it becomes effective immediately.

Satisfying the basic conditions of s17A

The only option available to an SMSF when the fund no longer meets SIS s17A is to either restructure within six months, become a small APRA fund or wind up and roll over to an APRA fund.

So there are some, but not many, choices available to rectify the situation.

SIS s17A also sets out the circumstances when it doesn’t satisfy the basic conditions but can remain an SMSF.

The first one is that it will continue to be an SMSF when it fails to meet the definition until:

1. It becomes an APRA fund or
2. It has been six months since it ceased to be an SMSF

As very few SMSFs choose to become an APRA fund, the six-month rule is the common one that applies, meaning that an SMSF has six months to restructure if it ceases to meet the basic conditions.

By way of example, if a single-member fund has two individual trustees and the member dies, the fund no longer meets the definition in s17A. However, it won’t breach s17A if it restructures within six months and meets the definition.

The fund must appoint another trustee (a relative of the existing trustee), and one must become a fund member.

The other alternatives, as previously mentioned, are that the fund can become a small APRA fund or wind up and roll over to an APRA fund.

Impact at audit time

From an audit perspective, no statutory time period applies to reporting s17A breaches. Once the fund ceases to satisfy the basic definition, it is reported after six months.

The ATO publishes a trustee disqualification register which is publicly available and includes all the details of disqualified trustees. A formal notice of disqualification is also published in the Commonwealth Government Gazette.

The unfortunate reality is that the register is not up to date. The most recent list includes all disqualifications processed to 31 December 2022, with the next update scheduled for May 2023 (not released at time of writing) covering disqualification action taken to 31 March 2023.

While SMSF auditors are notified about disqualified trustees directly by the ATO for recently audited funds, keeping track of the notifications is impossible.

Combine this with a delayed register of names, and most SMSF auditors rely on the trustee representation letter. There is no other practical way to ensure a trustee is not disqualified.

Director IDs

If the LPR is a director of the corporate trustee, they will require a director identification number (“director ID”) before being appointed. The reason is that civil and criminal penalties apply for not having one, which may result in a trustee disqualification

SMSF auditors cannot check whether a director of a corporate trustee has a director ID because the ASIC company statement does not list the number.

Further information is required from the ATO to confirm the requirements of SMSF auditors in this area.

Conclusion

Ensuring that an SMSF trustee is not disqualified can be challenging to navigate. There are specific conditions an SMSF trustee must meet to be a disqualified person.

While the ATO can disqualify a trustee based on not being a fit and proper person, repeated non-compliance with the SIS rules for high-risk breaches, such as illegal early release, will also bring about a negative outcome.

It’s not compulsory to have an SMSF, but it is mandatory to follow the rules. The integrity of the superannuation system depends on it.

Liability limited by a scheme approved under Professional Standards Legislation.

Visit ASF Audits to learn more about independent SMSF audits from Australia’s most trusted team or call 1800 327 872 and talk to Ben Atkins.