Prior to 2020, the bankruptcy rules were fairly straightforward. If you were declared bankrupt, you could no longer trade in your industry.
But that changed during COVID-19 with the Federal Government adopting US-style bankruptcy legislation that allows small businesses to trade while insolvent.
While there may not be direct changes to the way an SMSF is impacted by the collapse of a business, there could be indirect ways that could have major ramifications on SMSFs.
What happens when a member of an SMSF is faced with bankruptcy?
This part of the legislation has not changed. If an SMSF member is declared bankrupt, they need to move their superannuation benefit to another fund or sell their assets within six months of being declared bankrupt as they are a disqualified person under the SIS legislation.
Bankrupts are not allowed to appoint a legal representative to act in their place while they are disqualified. They need to remain out of the SMSF until they have been fully discharged, a process which usually takes about three years.
These members also need to resign as a trustee or as director of the trustee company, which is covered under the Superannuation Industry Supervision Act 1993 SIS Act. A new director will need to be appointed if the bankrupt person is the sole member of the SMSF and the sole director of the corporate trustee.
How do changes in bankruptcy legislation affect SMSFs?
COVID-19 hit many individuals and business owners hard in 2020 due to forced closures and lost earnings. The Federal Government threw a lifeline to small businesses at risk of collapse by allowing business owners to continue to trade while insolvent, which borrows heavily from the United States Chapter 11 bankruptcy provisions.
On the surface, it would appear this legislation does not impact SMSFs because any member who is bankrupt has to leave the fund anyway, even if they can continue to trade while insolvent.
Instead, the impact is more likely on the fund's investments. For example, according to the Australian Financial Security Authority, the most common industries to report personal insolvencies were construction, retail trade and accommodation and food services.
An SMSF could own a property that is currently rented by someone in those industries who are allowed to continue trading but may be struggling to pay the rent. This could cause a domino effect where there are cash flow delays which could in turn impact the ability of the fund to pay pensions.
This could lead to breaches of the pension standards or a fire sale of assets just to pay pensions as legally required. It shows the risk of using an SMSF to hold a single asset, especially when the SMSF is in pension phase. Trustees need to ensure their fund holds sufficient cash to meet its obligations.
It will require a watchful eye on property assets to ensure those rental payments do continue to roll in and the dominoes are not allowed to fall.
Graeme Colley is the Executive Manager, SMSF Technical and Private Wealth at SuperConcepts, a sponsor of Firstlinks. This article is for general information purposes only and does not consider any individual’s investment objectives.
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