BEWARE – trustee disqualification arising from the acquisition of an asset from a related party

Many news articles involving SMSFs come across my desk but the recent case of Merchant and Commissioner of Taxation [2021] AATA 915 (19 April 2021) really caught my eye. 

In this case, the applicants had been previously disqualified from acting as trustees of an SMSF by the Australian Taxation Office for actions which included breaches of sections 62 and 65 of the SISA, and Regulation 4.09 of the SISR. 

Whilst the case before the AAT only concerned an application for adjournment of the disqualification decision, a couple of issues included in the decision are worth contemplating.

Investment strategy - compliance is a must!

The decision of the AAT notes the ATO found the trustee's acquisition of listed shares in Billabong International from a related family trust, had breached regulation 4.09 as the trustee had not given effect to their investment strategy.  A focus only on the "give effect to" requirement of the regulation indicates the ATO did not find a problem with the way the investment strategy was constructed.  It therefore appears the trustee made an investment decision which didn't align with the strategy, and hence they didn't give effect to it.

As it's relatively straightforward to update an investment strategy when undertaking a significant transaction, this potentially indicates a lack of attention being given to the strategy by both the trustee, and the accountant advising on the transaction.  This is understandable to a degree as the share acquisition occurred in September 2014, well before the recent focus on investment strategies.

The inclusion of a breach of regulation 4.09 in the reasons for disqualification of a trustee must be particularly frustrating because a breach of this nature is 100% avoidable, as no matter what the trustee is doing, the investment strategy can be updated to align with the transaction.  What this does highlight is that regardless of how indifferent any trustee may feel towards their investment strategy, they must ensure their compliance with regulation 4.09.

Acquisition of listed shares from related party - would an SMSF auditor consider sections 62 and 65?

Also, from the AAT decision we learn that the SMSF's acquisition of the Billabong shares from the related party resulted in compliance issues other than just regulation 4.09.  However, interestingly the first section we would normally consider, section 66 (acquisition from related parties), was not one of them.  The absence of this section from the reasons for the disqualification allows us to conclude that the acquisition was at market value. 

The sections of the SISA which the trustee was found to have breached were sections 62 (sole purpose test) and 65 (financial assistance to the members).  Again, the case didn't go into much detail about the compliance breaches themselves however it appears the family trust received a tax benefit from the transaction by realising capital losses to offset against other gains, and that maintaining the market's confidence in Billabong shares was also a consideration behind the transaction.

I find it extremely interesting to hear of an instance where the ATO has determined that an acquisition from a related party, which didn't breach section 66, has breached other sections of the SISA.  This is because as auditors we would normally look for a transfer of a listed share to be at market value and that is where our audit work would end.  I believe it would nigh on impossible for an SMSF auditor to determine a breach of the sole purpose test in this instance as the auditor would not delve into all the possible reasons for the transfer and would not analyse the tax position of the other entities in the group.

The outcome of this case highlights that just because an SMSF auditor has reasonably formed an opinion that a transaction was free from compliance issues, trustees still need to be aware of the possibility of the ATO coming to an alternative conclusion when the transaction is approached from a different angle. 

If you are wanting truly independent auditor advice, please give Baumgartner Super a call on 1300 04 SMSF (1300 047 673) Australia-wide to learn more about our service.