ATO releases guidance on penalties for breaches of ancillary fund guidelines

The ATO has released PS LA 2014/1 outlining:

• how the Commissioner administers penalties for failure to comply with the ancillary fund guidelines;
• when directors of a corporate trustee may have a defence to the penalties; and
• when the Commissioner will remit such penalties.

The practice statement applies to both private and public ancillary funds, with some exceptions for funds operating under transitional rules.

The penalty regime

The Private Ancillary Fund Guidelines 2009 and Public Ancillary Fund Guidelines 2011 (Guidelines) set out rules that an ancillary fund and its trustee must comply with in order to be endorsed and remain endorsed as a Deductible Gift Recipient (DGR). Further, the Guidelines attribute penalties for breaches of their provisions.

Before the introduction of the Guidelines, there was no penalty, other than loss of DGR status, that could be levied on an ancillary fund or its trustee.

The penalty regime under the Guidelines is aimed at ensuring trustees are properly accountable and act in the manner expected of a trustee holding philanthropic funds for a broad public benefit.

Trustees of funds as well as directors of corporate trustees can be jointly and severally liable for penalties if the trustee holds the fund out as being endorsed, entitled to be endorsed or entitled to remain endorsed as a DGR and the fund is not so endorsed or entitled.

A penalty will only be imposed on directors of a corporate trustee where the penalties cannot reasonably be recovered from the trustee itself. This liability does not extend to a director of a licensed trustee company or a director of a public trustee of a state or territory.

The Commissioner has indicated that action will usually be taken against those directors that, in combination, would achieve recovery in the timeliest manner.

The penalty payable by the trustee will correspond to the severity or consequence of the Guideline (or Guidelines) that were breached.

Defences to and remission of penalties

Before commencing any action against a director of a corporate trustee, the Commissioner will consider whether there are any defences available to the directors as well as their capacity to pay the penalty.

A statutory defence may be available to directors in the following circumstances:

• if a director was not aware of the breach, and it would have been unreasonable to expect them to have been aware of the breach; or
• a director took all reasonable steps to ensure the breach did not occur; or
• there were no such steps that the director could have taken.

The director has the responsibility of proving that one or more of the defences apply.

The question of whether it is reasonable to expect the director to have been aware of the breach is an objective test. The effort required will be one commensurate with all the director’s circumstances including the director’s knowledge, education, experience and skill.

Trustees and directors are expected to act with care, skill and diligence. From this duty of care flows the ‘reasonable test’, based not on whether a trustee generally tries to act with care and diligence, but rather on whether a trustee in the same position and circumstances would have acted in the same way as the person in question. This is the benchmark that the Commissioner will measure any actions against.

Once a penalty is determined, the Commissioner has the discretion to remit all or part of the penalty, with remission decisions being made separately for each trustee or director liable for the whole or part of the penalty.

In deciding whether to remit a penalty the Commissioner will have regard to the high level of care expected of trustees of philanthropic funds, the major objective of the penalty regime (consistent treatment), and the provision of the Guidelines that has been breached.

The Commissioner has indicated that it would be unlikely that a decision in favour of a remission of a penalty would be given in respect of a breach of the Guidelines dealing with the investment obligations of the trustee and prohibited transactions due to their importance as integrity assurance measures.  A trustee or director of a trustee who has been levied with a penalty that has not been fully remitted may object to the Commissioner’s decision.

Importantly, penalties cannot be paid from the ancillary fund itself and further, the power of the court under the Corporations Act 2001 to grant relief in case of breach of a director’s duty does not apply to a liability of a director for an administrative penalty of this nature.

Examples and lessons

The practice statement sets out some useful, but not binding, examples to illustrate how the Commissioner may determine the question of remission of penalties.

The following lessons can be taken from the examples:

• If a trustee acts immediately upon identifying a breach, takes steps to ensure a mistake is not made again (for example, by arranging training) and voluntarily discloses the occurrence of a breach before its audit process, the ATO may remit the penalties in full.
• Where a trustee does not pay attention to record keeping, should have been aware of contraventions and takes no steps to remedy breaches, no remission of penalties is warranted.

Further, a trustee who also has a busy professional role is not excused from the relevant requirement and has no justification for applying a lower standard of care.   • Where a trustee of a private ancillary fund engages a bookkeeper to assist with record keeping and other requirements and provides the bookkeeper with all information needed to carry out their duties but the bookkeeper does not carry out the necessary duties appropriately, a director of the trustee may be entitled to have penalties levied against them remitted in mitigating circumstances, such as where the director is suffering from a serious illness and recovering from surgery.   • However, the size of the fund and use of the assets of the fund during the relevant period may be relevant factors to be considered in making the determination and importantly, the same statutory defence may not apply to other directors of a corporate trustee not suffering from the same impairment as the director described above.   • The Commissioner will not consider a remission of penalties where a trustee fails to make information available to the Commissioner upon request, without providing evidence as to circumstances preventing such disclosure.   • Where a corporate trustee of an ancillary fund has no funds available to pay penalties, the ATO will seek to recover the penalties from the directors.

 When determining which directors to seek recovery from, the ATO will take into consideration the potential defences available to a director and the director’s capacity to pay the penalties.

Where one director takes steps to investigate potential contraventions and other directors are uncooperative, the ATO may determine that it is appropriate to impose penalties against some but not all directors.   • Where an ancillary fund undertakes substantial investment activities that are planned, organised and carried out in similar manner to those of other investment companies and engages personnel to manage its investment function, it is likely that the fund is carrying on business. In these circumstances a penalty imposed for contravention of the applicable Guidelines will not be remitted if the trustee has, in the Commissioner’s view, acted without regard to the relevant requirements.   • In addition to not remitting penalties, the Commissioner may also refer a contravention of the Guidelines to the state Attorney General for action under applicable trust laws. This may occur where a trustee and its directors deliberately disregard their obligations by, for example: • paying excessive salaries to a founder; • providing interest free loans to family members of a founder; • failing to make payments in pursuit of charitable purposes; • providing material tax or other benefits to a founder; or • failing to maintain the ancillary fund solely for charitable purposes.

• Where one or more directors act fraudulently to keep their actions from another director, the information the director is provided with and relies on contains false representations that the director was not aware of and the director was not a director at the time when contraventions occurred, the Commissioner may decide not to impose penalties on all directors.   • Where an ancillary fund is established and operates without a written investment strategy and later implements a written investment strategy but doesn’t comply with it, penalties will apply for separate and distinct breaches, particularly where the trustee fails to document any associated decision-making processes in relation to investment activities.   If you have any queries regarding the penalty regime for ancillary funds or in relation to ancillary funds generally, please contact a member of our team.  – See more at: https://cgw.com.au/legal-alerts/april-2014/ato-releases-guidance-on-penalties-for-breaches-of-ancillary-fund-guidelines#sthash.TsrH9gt4.dpuf