Can Bankrupt Individuals Be Members of SMSFs?
Overview
Self Managed Super Funds (SMSFs) are a popular retirement savings structure in Australia, allowing members to manage their own superannuation investments. However, there are strict regulations regarding who can be a member or trustee of an SMSF, especially in situations involving bankruptcy.
Bankruptcy and SMSF Membership
Under Australian law, specifically the Superannuation Industry (Supervision) Act 1993 (SIS Act), a bankrupt individual cannot act as a trustee of a superannuation fund, including an SMSF. This is because the law aims to protect the assets held in SMSFs and ensure trustees act in the best interests of all members.
Disqualification of Trustees
– If a person becomes bankrupt, they are automatically disqualified from being a trustee or director of a corporate trustee of an SMSF.
– The moment a member is declared bankrupt, they cannot continue to act in their capacity as a trustee.
– If a current SMSF member becomes bankrupt, they must notify the Australian Taxation Office (ATO) immediately.
Membership Status
– While an individual can technically remain a member of an SMSF during bankruptcy, they cannot act as a trustee.
– Australian law requires all SMSF members to also be trustees (or directors if the SMSF has a corporate trustee). If a member is unable to fulfil this requirement due to bankruptcy, the fund will generally cease to be an SMSF unless a new trustee arrangement is established (e.g., appointing an approved legal personal representative).
– According to section 17A(1) of the Superannuation Industry (Supervision) Act 1993 (SIS Act), “each member of the fund is a trustee of the fund and each trustee is a member of the fund.” This legal requirement ensures that members have direct and active involvement in the management of their self-managed super fund (SMSF). When a member becomes bankrupt, however, section 120(1)(b) of the SIS Act states that “a person who is an undischarged bankrupt” is a “disqualified person” and cannot act as a trustee or director of a corporate trustee. This means the SMSF can no longer satisfy the definition of an SMSF under the law unless changes are made.
– In practice, if a member becomes bankrupt and cannot remain as a trustee, the fund “will generally cease to be an SMSF unless a new trustee arrangement is established,” as explained by the Australian Taxation Office (ATO). One such arrangement is to appoint a legal personal representative (such as a registered trustee or executor) to act in place of the bankrupt member, as permitted under section 17A(3) of the SIS Act.
A registered trustee, in the context of bankruptcy and SMSF management, is an individual or corporate entity who is registered and regulated by the Australian Financial Security Authority (AFSA) to administer bankrupt estates. Only persons or bodies registered under the Bankruptcy Act 1966 can serve in this capacity.
Typically, a registered trustee can be:
- An individual professional: This is usually a qualified insolvency practitioner, such as a chartered accountant or lawyer, who has demonstrated the necessary experience and competence in administering bankruptcies and has been formally registered by AFSA.
- A corporate trustee firm: Many accounting and specialist insolvency firms hold corporate trustee registrations and employ multiple registered trustees who can be appointed to manage bankruptcy estates.
To be appointed as a legal personal representative for a bankrupt SMSF member, the trustee must not be a ‘disqualified person’ under the SIS Act and must comply with all regulatory requirements. Their role is to act in the best interests of the bankrupt individual, ensuring compliance with both bankruptcy law and superannuation legislation.
In summary, only those individuals or companies registered by AFSA as trustees under the Bankruptcy Act, and who meet all suitability criteria set out in relevant legislation, can act as a registered trustee in these circumstances.
The ATO advises, “If the fund does not restructure within the allowed timeframe—generally six months—then it may become non-compliant and lose its tax concessions” (ATO, “Disqualified persons and trustees”).
– Maintaining compliance is critical, as non-compliance can result in the SMSF losing its concessional tax status, facing penalties, or being forced to wind up. Therefore, trustees and members must act swiftly to restructure the fund if one member is disqualified due to bankruptcy, typically by rolling over their benefits to an APRA-regulated fund or appointing a legal personal representative in accordance with legislative requirements.
Implications for SMSF Compliance
– If the SMSF is left with a bankrupt member who cannot act as trustee, the fund may become non-compliant with the SIS Act and lose its concessional tax status.
– The fund has up to six months to restructure so that it complies with legislation (such as rolling the bankrupt member’s benefits to a public offer fund and removing them as a member/trustee).
Converting to a Small APRA-Regulated Fund
Another potential solution in circumstances where a member of an SMSF becomes bankrupt is to convert the Self Managed Super Fund into a small APRA regulated fund (SAF). A SAF is similar in structure to an SMSF; however, its key distinction lies in having an approved trustee appointed by a professional trustee company, as required by APRA (the Australian Prudential Regulation Authority).
This conversion relieves the fund from the requirement that all members must also be trustees or directors of the trustee company. Instead, an APRA-licensed trustee assumes responsibility for compliance, administration, and reporting. This can be particularly advantageous when a member is disqualified—such as in bankruptcy—since the ongoing eligibility of members to act as trustees is no longer an issue.
The process of converting an SMSF to a SAF involves:
- Appointing an APRA-approved trustee company to manage the fund’s operations and compliance obligations.
- Updating the fund’s trust deed and registration details to reflect the new structure.
- Notifying the ATO of the change and satisfying all regulatory requirements for the transition.
Key considerations include additional compliance costs (as fees will be charged by the professional trustee company), reduced direct control for members, and ensuring that the fund’s investment strategy remains appropriate under the new structure.
However, this option allows the fund to retain its concessional tax treatment, continue to operate without requiring the exit of a bankrupt member, and remain compliant with superannuation law, provided all APRA requirements are met.
Summary
A person who is an undischarged bankrupt cannot be a trustee or director of a corporate trustee of an Australian SMSF. While they can technically remain a member, the rules require all members to also be trustees, which means the fund must take action (such as the bankrupt member exiting the fund or appointing a legal personal representative) to maintain compliance. Failure to do so can have significant regulatory and tax consequences for the SMSF.