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When an SMSF member becomes bankrupt

Australia’s SMSF sector has experienced tremendous growth over the past decade, with a vast majority of funds now being set up with two members, usually a husband and wife or de facto couple.

While sharing an SMSF has become a popular option amongst couples, SMSF members need to be aware of the rules that govern their fund, including what to do when one member becomes bankrupt.

A requirement of an SMSF is that each individual trustee of the SMSF must be a member of the SMSF. In the case of corporate trustees, every member must be a director. Ultimately, this has ramifications further down the line since all members are connected and held accountable for one another. Consequently, if one member enters bankruptcy, that will also mean one of the trustees has entered bankruptcy.

In addition, the laws governing SMSFs also state a “disqualified person” cannot act as trustee of the SMSF.

Where a disqualified person continues to act as an SMSF trustee or director, the fund may lose concessional tax status as it will be considered to be non-compliant. In addition, this may trigger a significant tax liability where the previous tax concessions are “clawed” back.

The ATO provides a six-month ‘grace period’ to allow a restructure of the SMSF so that it either meets the basic conditions required or can be rolled over into an industry fund.

During the six-month grace period, the ATO requires:

  • the bankrupt to remove themselves as trustee
  • the bankrupt to inform the ATO in writing
  • to be notified within 28 days if there is a change in trustee
  • the bankrupt to notify ASIC of the resignation as a director (if the SMSF is run by a corporate trustee)

If one member of an SMSF enters bankruptcy, they must resign as trustee as soon as possible. The other member will need to remove the bankrupt’s balance from the SMSF before the grace period is over, this may involve:

  • selling any real estate or shares
  • transfer the bankrupt’s balance to a managed fund
  • consider whether they want to remain as a single member SMSF, or roll over their entitlements to a managed fund.

For members who enter bankruptcy, they must sell all assets for the market value available at the time, and then transfer all of the liquid assets to a managed fund.

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