If Trustees do not follow the rules for running an SMSF (i.e. a breach occurs) the ATO has a range of penalties that can be applied.
If a breach occurs it is best to work with the ATO to rectify the issue as penalties may be less harsh if genuine efforts are made to rectify them.
If the breach is severe, the ATO may declare the SMSF to be non-complying which could see almost half (45%) of the market value of the fund disappearing as a tax penalty and higher tax levels ongoing (at top marginal tax rate).
The ATO can also prosecute the trustees with heavy fines or jail sentences.
Penalties apply if an SMSF does not lodge an annual return. The ATO issues non-compliance notices to SMSFs trustees that fail to lodge their annual return and refuse to comply with requests to lodge.