Background
James Smith, aged 60, has $2M in his self-managed superannuation fund (SMSF) and has decided to retire following the liquidation of his business. The liquidation only paid creditors 20 cents on the dollar, with the ATO as the main creditor. James made $60,000 of contributions into superannuation - $20,000 of them SGC - required under law just prior to a liquidator being appointed. The ATO is now seeking to appoint a trustee in bankruptcy and has issued a letter to the Trustee of the Smith Super Fund requesting payment of the $2M in superannuation to satisfy outstanding tax debts.
The Smith Super Fund has a corporate trustee, Smith Pty Ltd, where James and his wife (who has $1M in super and is 51 years old) are both directors.
Is this legal?
The key legal question is whether the ATO can claim James' superannuation assets to satisfy his tax debts and what steps the SMSF trustee should take in response.
Legal Framework and Analysis
1. Protection of Superannuation from Bankruptcy
Under Section 116(2)(d)(iii)(A) of the Bankruptcy Act 1966, superannuation funds are protected assets in bankruptcy, meaning creditors—including the ATO—cannot access James’ super directly.
However, Section 128B of the Bankruptcy Act 1966 provides that if James made contributions to his super with the intention of defeating creditors, those contributions can be clawed back.
A critical issue is whether James has been making unusually large contributions to his SMSF in the period leading up to his insolvency. If these contributions are deemed to have been made to defeat creditors, they can be reclaimed by the bankruptcy trustee. However SGC payments are required by law and thus fall outside section 128B - the other contributions the company has made on his behalf not so.
2. Impact of Bankruptcy on SMSF Trusteeship
Superannuation funds cannot have a disqualified person as a trustee or director of the corporate trustee - section 126K of Superannuation Industry (Supervision) Act 1993.(SISA). Section 120(1)(b) provides that an undischarged bankrupt is a disqualified person.
Importantly all members of a SMSF must be a trustee or director of the Fund's corporate trustee unless a person is appointed who holds the member's enduring power of attorney. However we cannot use this as an escape for his spouse to act on his behalf on the grounds she holds his EPOA, as section 17A(10) excludes an attorney acting on behalf of a disqualified person.
Sub-section 17A(4) of SISA provides that the options for the remaining for the Trustee and sole director of Smith Pty Ltd (his spouse) in relation to John's fund membership (to retain SMSF status) is:
remove him from membership of the fund within the period of 6 months from the date of disqualification, or
appoint an APRA regulated trustee to the Fund.
3. Pension Phase and Creditor Access
Once a member starts drawing a pension, those pension payments can be subject to creditor claims as they are not exempt - section 116(2)(d)(iv) of the Bankruptcy Act.
However, lump sum withdrawals remain protected under that sub-section. If James withdraws a lump sum during and after bankruptcy is declared, those lump sum withdrawals are protected.
Recommended Actions for the SMSF Trustee
**1. Send a Legal Letter to the ATO
The ATO’s request to the trustee has no legal standing. Superannuation in a complying SMSF is not available to creditors unless a claw-back provision applies.
The trustee should formally respond to the ATO stating that the fund is legally protected under the Bankruptcy Act and that James’ benefits are inaccessible and see what happens in relation to claw backs.
2. Ensure SMSF Compliance
Immediate Action: James must resign as a director of Smith Pty Ltd if he is declared bankrupt.
Ensure the fund remains compliant: His wife (or another non-disqualified person) can remain in and continue managing the SMSF.
Transfer James’ balance to a retail or industry super fund before or within six months of bankruptcy being declared, as this will remove the SMSF compliance burden. This also helps as then the Trustee of the industry super fund will have to legally battle the ATO and if they step out of line, John can seek recompense under AFCA.
3. Strategic Withdrawal of Funds
During bankruptcy James may withdraw a lump sum from his superannuation. Lump sum withdrawals are protected once in his hands, but should be managed carefully.
He should avoid capital expenditure and only withdraw that money he needs to live on.
4. Protecting the Family Home
If the family home is in James' name, it may be at risk from creditor claims. Subject to the four year claw back, undervalued transaction and gifting rules some options to protect the home:
If jointly owned, ensure it is structured under tenants in common or transfer to his spouse rather than joint tenancy to limit exposure.
If the mortgage is paid off, consider transferring ownership to a family trust (this must be done well before bankruptcy to avoid claw-back provisions).
Use the Protector to shift wealth to a Family Protection Trust.
Summary
The ATO cannot force the trustee to release James’ superannuation with the exception of contributions made to defeat creditors. However, if James is declared bankrupt:
He must resign as a director of the corporate trustee.
His superannuation balance may need to be transferred to a retail fund.
Strategic lump sum withdrawals before bankruptcy may provide additional protection.
To safeguard his wealth, James should act quickly with legal and SAPEPAA advice to ensure his assets remain protected while complying with superannuation and bankruptcy laws.
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