What Happens If I Become Bankrupt or Enter Into a Personal Insolvency Agreement and I Have an SMSF?

Bankruptcy sign with scattered coins and a miniature house in the background. Seek the advice of a trusted tax accountant to help with financial planning and avoid financial difficulties.

With interest rates on the rise and the cost of living at all-time highs, some of us may be experiencing financial headwinds and an impending thunderstorm of bankruptcy or entering into a Personal Insolvency Agreement (PIA). If this happens, then what should one do in this instance?

Firstly, don’t panic.

Such challenges may arise due to external factors which are beyond our control and/or are no fault of our own. So, what should you do as a trustee of an SMSF when you realise that you are about to become bankrupt or enter a PIA?

Should I try to keep it a secret from my SMSF accountant or administrator?

No, sweeping the matter under the carpet until the annual financial statements and tax return are being audited a year later is not a good idea. By doing so, valuable time is lost, especially since there is a strict timeframe in which action must be taken should a SMSF member become a “disqualified person”. If this is not adhered to, then it puts the fund at risk of becoming a non-complying SMSF.

What is a “disqualified person”?

Where a member becomes insolvent under administration (which includes a person who is made bankrupt and is not discharged), they are a “disqualified person” per sub-section 120(1)(b) SIS Act. This means that from that day they cannot be a trustee of an SMSF or a director of a company that acts as trustee of an SMSF.

As the disqualified person is a member of the SMSF but cannot be a trustee or director, the SMSF fails the basic conditions in section 17A of the SIS Act. The fund has 6 months to rectify this situation.

Can I appoint an Enduring Power of Attorney to act in my place?

No. The individual that has been disqualified cannot use any of the usual provisions under an enduring power of attorney to appoint a trustee or director in their place. That is, the removal of the individual is compulsory.

What happens to my SMSF if a member, trustee or director becomes a disqualified person?

The primary alternatives are as follows:

  1. Roll the member out of the fund to an APRA regulated fund
    – This will require the fund to have sufficient cash to effect the rollover, or for the receiving fund to be permitted to accept in-specie rollovers of assets.
    – There are no changes for all other members, trustees, directors of the fund as they can remain in the SMSF.
  2. Restructure the SMSF into a small APRA Fund (SAF)
    – A SAF is very similar to an SMSF with the primary differences being that the trustee is required to be an independent professional trustee and that it is regulated by APRA and not the ATO.
    – The remaining trustees will need to confirm whether the independent trustee will accept all assets of the SMSF as assets of the SAF, as there may be restrictions on the type of assets the SAF can hold (in addition to the rules under the SIS law). They can also provide an outline of the process of restructuring of the SMSF to the SAF and the associated costs.
  3. Windup the SMSF
    – Depending on the age and employment status of the disqualified person, they may have unrestricted access to their superannuation to withdraw it all in cash as a lump sum, subject to the liquidity of the fund assets. Care would need to be taken as to whether this alternative makes logical sense, keeping in mind that you are in the middle of a bankruptcy and it may expose your fund to the bankruptcy trustee;
    – Otherwise, the disqualified person will need to rollover their benefits to an APRA regulated fund.

Do I need to notify the ATO or ASIC and is there a timeframe to restructure the SMSF?

Yes, the ATO and ASIC need to be notified within 28 days when an individual becomes a disqualified person.

The SMSF will have 6 months to restructure the fund-this time frame is fixed and strict.

Should the disqualified person no longer be bankrupt or the PIA ceases within the 6-month period, then they can return to being a trustee or director of the corporate trustee.

ASIC also needs to be informed at the end of the 6-month period.

What are the penalties if a disqualified person continues to act as a SMSF trustee?

Failure to inform the ATO about the disqualification status of a trustee is an offense. Should they continue to act and breach these rules, then they are liable for criminal and civil penalties, including up to 2 years in jail and a fine of up to $10,200.

As always, if you foresee a problem as described above, please call your client manager to discuss.

Author – Anna Wong

*Correct as of 27 September 2022

*Disclaimer – this article has been produced by Kreston Stanley Williamson as a service to its clients and associates. The information contained in the article is of general comment only and is not intended to be advice on any particular matter. Before acting on any areas contained in this article, it is imperative you seek specific advice relating to your particular circumstances. Liability limited by a scheme approved under professional standards legislation.

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