Penalty in borrowing super to keep a business afloat

Difficult business times (seems to be a rather common theme in many of my articles lately) can cause business owners to do things they ordinarily would not do.

A recent case before the Administrative Appeals Tribunal (AAT) has highlighted the dangers in businesses accessing superannuation to help out in tough times.

Mr and Mrs Smith ran a real estate agency. In previous years, they had incurred considerable expense in legal costs arising from actions in various courts. As a result of these legal proceedings, they lost possession of their then family home, and the real estate business deteriorated.

In 2007, Mrs Smith and her husband had purchased another home which was subject to a mortgage. In 2008 their bank, without notice, informed them that it would no longer extend credit to the real estate business. After seeking professional advice, Mr and Mrs Smith were advised to place the real estate business into voluntary administration.

Mrs Smith claimed voluntary administration was not a realistic option as it would require the forced sale of their only real asset, the real estate company’s rent role. She considered that the only other option available was to access monies from her self-managed super fund to maintain the business.

So, to avoid putting the business into voluntary administration, Mrs Smith accessed some $87,000 over two years (in two amounts of $50,000 and $37,000 in the 2008 and 2009 tax years) from her self-managed super fund (SMSF) so as to help maintain the business. The business survived and she later returned the money to the fund.

The AAT said Mr and Mrs Smith did not themselves directly benefit from the payments out of the super fund but the monies were used solely for the purpose of preserving the business. The business was saved.

The AAT acknowledged that it was “difficult not to have sympathy with the [Smith’s] dilemma”. It said the use of the monies allowed the real estate business to continue and that business had in turn paid wages to employees who have paid, and continue to pay, tax on those wages. The Tribunal agreed with Mrs Smith that if the business had been allowed to fail, the then employees of the business and both she and her husband would have been forced to seek Social Security benefits, so that the public purse has benefited by the payments out of the super fund.

The Tax Commissioner included the amounts in Mrs Smith’s assessable income for the 2008 and 2009 income years as the payments to her from the fund were paid in breach of the legislative requirements under the superannuation law – the Superannuation Industry (Supervision) Act 1993 and the Superannuation Industry (Supervision) Regulations 1994. Mrs Smith did not disagree the payments breached the law.

The Tax Commissioner nonetheless has a discretion under the tax law not to include the amounts in assessable income where to do so would be “unreasonable” having regard to the nature of the fund and any other relevant matters.

The Commissioner declined to exercise his discretion. Mrs Smith argued that this discretion should have been exercised. She contended, as noted above, that the public purse had benefited by the payments out of the super fund as the payments had enabled the business to continue paying wages (and therefore tax was paid).

The AAT upheld the Commissioner’s decision not to exercise his discretion. While the discretion is largely unfettered, the AAT held that the context of the discretion in the tax law (in the Income Tax Assessment Act 1997) meant that SMSFs were not to be used as a “lender of last resort”. The AAT expressed sympathy for the Smith’s dilemma but noted the wider concepts that the tax benefits provided to SMSFs are “a privilege that should not be abused”.

Mrs Smith’s argument might be thought to be compelling and logical, especially as the business survived and the money was paid back to the fund. The “borrowing” of the funds from the super fund was not however in accordance with the relevant superannuation laws and the Commissioner was correct to include the moneys in Mrs Smith’s assessable income.

But what if the business had not survived? Same result in effect – Mrs Smith would still have had the moneys included in her income even though the money from the super fund would have been lost.

More fundamentally, however, the money (whether the business survived or not) would not have been used for its primary purpose, ie. the provision of retirement benefits to the Smiths.

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions .

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