Rectification directions

What are they?  They are a written direction from the ATO requiring the trustee to take specified action to rectify a contravention.  The direction must specify a time period in which the action must be completed (which is required to be a reasonable time).  

What is rectification anyway?  Rectification will generally involve putting into operation managerial or administrative arrangements that could reasonably be expected to ensure that there are no further contraventions of a similar kind.  In certain cases, rectification may involve closing out transactions (eg terminating a lease to a related party, paying off a non-complying loan or selling assets or transferring title).

When can they be issued?  The ATO may issue a rectification direction to a trustee of an SMSF if the ATO believes (on reasonable grounds) that the trustee has contravened a provision of the SIS Act or regulations which apply to SMSFs.  However, the ATO must, before giving such a direction, consider any financial detriment which might be suffered by the SMSF if the rectification is undertaken, the seriousness of the contravention and any other relevant matter.

Comment:  It seems that the ATO cannot issue a rectification direction to a trustee who has not been involved in the contravention.

Comment:  It seems that the ATO cannot issue a rectification direction where the cost of rectification is disproportionate to the contravention.  For example, if the SMSF failed to keep audited financial statements for the minimum period of 5 years, rectification by reconstructing those financial statements may be a disproportionate cost.  But rectification by implementing a better record management system may be acceptable.

Another example could be where real estate of the fund becomes an in-house asset because a related party is using or renting the property.  It may be a disproportionate response to require the real estate to be sold rather than simply terminating the use or rental arrangement at the earliest possible time.

Comment:  Contesting the issue of rectification directions on the grounds that the implementation of the direction will impose a disproportionate cost on the SMSF may become an interesting area of submission to the ATO and appeals to the AAT.

What if the trustee fails to comply?  If the trustee fails to comply with the direction, the trustee will be liable to a maximum penalty of $1,700 (ie 10 penalty units).  As the penalty is strict liability, no excuses for failure to comply will be permitted.

Who bears the cost of implementation of the rectification direction?  The legislation does not preclude the SMSF from bearing the cost of the rectification direction.  These costs could be legal costs, accounting costs, registration fees and charges.  However whether the trustee is able to be reimbursed by the SMSF will depend on whether the cost is a properly incurred trustee expense.  If the reason for the issue of the rectification direction is that the trustee failed to exercise reasonable care and skill, the trustee may not be permitted under trust law to be reimbursed.

Comment:  SMSF Trustees should review any insurance cover they have to determine whether rectification expenses which cannot by trust law be reimbursed by the SMSF are covered.