Neal Dallas, principal at McInnes Wilson Lawyers looks at the circumstances in which a trustee in bankruptcy may look to claw back superannuation contributions made prior to bankruptcy.

In Part 1 of this series we looked at the rules which generally protect superannuation interests and payments out of superannuation funds following a bankruptcy. In this follow up article we look at the circumstances in which a trustee in bankruptcy may look to claw back superannuation contributions made prior to bankruptcy.

Contributions may be exposed

Although, as we discovered in Part 1 of this series, the Bankruptcy Act 1966 (Act) appears to provide protection for superannuation benefits, it is important to consider the provisions of the Act which allow a trustee in bankruptcy to claw back certain superannuation contributions made prior to bankruptcy.

Provisions in the Act enable a trustee in bankruptcy to recover superannuation contributions made with the intent or deemed intent to defeat a bankrupt’s creditors. The subdivision applies to contributions made by the member or by a third party where that third party is party to a scheme to make the contributions (e.g. an employer, particularly where a salary sacrifice arrangement is implemented; or spouse making spouse contributions).

The anti-avoidance measures allow for the recovery of contributions made where the main purpose of making the contributions was to prevent the transferred property becoming divisible among the transferor’s creditors or to hinder or delay the process of making property available for division among the transferor’s creditors.

When looking at the main purpose of the contributions, two factors are considered: the member’s solvency at the time the contribution was made; and the pattern of contributions.

In determining the pattern of contributions, it is relevant to consider whether contributions have been made ‘out of character’. Where a member has been consistently contributing to a fund, it will be more difficult to suggest that contributions are made ‘out of character’. Conversely, where only the minimum superannuation guarantee contributions had been made for the member, but shortly prior to bankruptcy the member made larger non-concessional contributions or contributions under the CGT cap, it may be easier to infer the contributions were made ‘out of character’.

It is difficult to predict the precise circumstances in which contributions might be clawed back. For example, if a member realises a capital gain which allows them to make contributions under the small business CGT concessions (in some instances up to $1.48M in the 2018/19 year), or a member is able to make “downsizer contributions” (up to $300,000 from 1 July 2018 where a person aged over 65 sells their main residence which they have owned for more than 10 years) or simply makes non-concessional contributions (of up to $300,000 applying the bring forward rules), will such contributions be liable to be clawed back? The ability to make CGT and downsizer contributions arises because of particular circumstances which may have arisen coincidentally, or might have been orchestrated. Ideally the individual should be able to provide some evidence of the former – e.g. the business had been on the market, or they had intended to downsize their residence because their adult children had left home, independently of the circumstances which gave rise to their bankruptcy. It may, however, be difficult to show conclusively that the two were not connected. It will ultimately come down to the determination of a court if there is any dispute between the member and the trustee in bankruptcy.

It is worth noting that the lowering of contribution caps – Concessional Contributions of $25,000 per annum, and Non-Concessional Caps of $100,000 with a limited ability to bring forward 2 future years’ non-concessional contributions into the current year – has indirectly lessened the likelihood of clawback given that there is now reduced ability to make large one-off contributions. Nevertheless, the ability to make CGT contributions (in some cases up to $1.48M), downsizer contributions (up to $300,000), and in time catch up concessional contributions (up to $125,000) may still allow reasonably large contributions to be made in a short period of time which a trustee in bankruptcy may seek to claw back.

$1.6 million transfer balance cap

From 1 July 2017, a $1.6M cap applies to the total value of a superannuation interest that can be used to support an individual’s retirement income stream (i.e. the income from assets in that account are not taxed).

From a bankruptcy perspective, where the value of the superannuation interest supporting the retirement income stream is reduced because amounts are clawed back under the Act, the individual is able to notify the Commissioner of Taxation and receive a debit in their transfer balance account to the value of the reduction. There is no time limit within which the commissioner needs to be notified. The debit reduces the balance of the transfer balance account, which may give the member capacity in the future to commence or increase income streams.

Reminder for SMSFs

Although the bankruptcy protection laws do not distinguish between Self-Managed Super Funds (SMSF) and large superannuation funds, it is important to remember that a ‘disqualified person’ is prohibited from acting as trustee of a superannuation entity. This includes a bankrupt.

As such, if a person has an SMSF, they must resign as a trustee (or director of the corporate trustee) upon becoming bankrupt. After they have resigned, the SMSF will then initially fail to meet the basic conditions necessary to be an SMSF because there will be a member who is not a trustee. The SMSF has a period of grace of six months in which to restructure. Restructuring can include rolling the bankrupt’s superannuation interests to a non-SMSF. Alternatively, a Registrable Superannuation Entity (RSE) can be appointed to act as trustee of the SMSF (at which point the fund would stop being an SMSF and become a small APRA fund). Although RSE licensees can be expensive, this may be preferable where the fund has non-liquid assets that cannot easily be rolled over to another superannuation fund.

How can McInnes Wilson Lawyers help?

Our Revenue, Structuring and Succession team is able to advise those facing bankruptcy and assess their options in relation to superannuation interests and payments. In doing so, we can ensure that a bankrupt’s superannuation is effectively utilised in a time of financial hardship.

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