Super Snippets: Year to date
- Government releases ‘Tax White Paper’ and ‘Intergenerational Report’
- Tax office decisions on limited recourse borrowing and death benefits
- Munro case highlights importance of getting estate planning right
- Other court/tribunal decisions show what not to do with your SMSF
- New superannuation thresholds
Welcome to our first ‘Super Snippets’. Super Snippets is a monthly article that highlights key new developments affecting SMSF trustees and other self-directed investors. We’ll also provide links to external material that might be of interest.
The purpose of Super Snippets is to alert you to matters and how they might affect you, not to be a lengthy technical resource. We encourage you to follow up on any issues of concern via Q&A.
Let’s turn now to the key developments so far in 2015.
On 5 March, the Government released the 2015 Intergenerational Report. This report, released every five years, assesses the long-term sustainability of policies and the impacts of changes in population and age profile on the economy, workforce and public finances over the next forty years.
You can read the full report via the link above but the main takeaway is that Australia’s population is expected to grow, and age, substantially in the coming decades due to increasing life expectancies. As you’d expect, this places pressure on public finances.
There have been various thought bubbles from politicians and others on what this might mean for the superannuation system and age pension. But no-one really knows how the future will play out.
The main lesson is simply that you should expect the superannuation and age pension systems to become less generous over the coming decades. When doing your retirement forecasting, expect to pay more tax (or some tax) on super – especially if you’ve got a multi-million dollar balance, or expect to make large capital gainsThe profit that an investor makes when they sell an investment or (if unrealised) the profit they would make if they sold the investment for its value at that time. – and for the age pension to be less generous and tougher to get in the first place.
The report should also serve as a reminder to utilise strategies that reduce your exposure to ‘change of law risk’. For instance, re-contribution strategies (withdrawing your super and re-contributing it) can be used to convert the taxable component of your super balance into tax-free and even up the balances between spouses. Super splitting is another way to even up balances.
Adopting strategies like these should mean you’re less chance of being taxed on your super pension account down the track.
The Government also released their Tax White Paper – Re: think – on 30 March. The paper doesn’t make any specific recommendations about the superannuation system, but simply raises questions of equity and fairness.
However since that time there have been rumours circulating through the mainstream media about various measures the Government has been considering for the upcoming Federal budget. For instance, we’ve seen suggestions they may limit lump-sum withdrawals, or re-introduce a ‘pension tax’ on large account balances.
In an environment where the Government is struggling to match expenditure with revenue, new taxes are always a possibility, however we expect there will be greater consultation before more meaningful structural change is enacted. In the meantime the White Paper, like the Intergenerational Report, is a reminder that we can expect things to get tougher for super – especially large account balances – in the future.
Action point: If you’re planning a lump sum withdrawal or re-contribution strategy, it might be better to do it before Budget night if there’s no downside in doing so, just in case there’s a rule change that stops you doing so.
ATO determinations on limited recourseA loan is said to be ‘limited recourse’ when the claim of the lender is limited to the value of the assets used to secure the loan. This prevents the lender having any further ability to claim against the borrower. SMSF property loans are an example of a limited recourse loan (the law requires these loans to be limited recourse). borrowing arrangements
The first ATO decisions we’ll highlight are two that were published right at the end of 2014.
In December, the ATO released two public decisions (ATO ID 2014/39 and ATO ID 2014/40) that explain its treatment of non-commercial, limited recourseA loan is said to be ‘limited recourse’ when the claim of the lender is limited to the value of the assets used to secure the loan. This prevents the lender having any further ability to claim against the borrower. SMSF property loans are an example of a limited recourse loan (the law requires these loans to be limited recourse). borrowing arrangements used to purchase both shares and property.
Interpretative decision ATO ID 2014/39 relates to a case where a related party loan was used to fund 100% of the purchase price of a portfolio of shares. The loan was made for a term of 20 years, with zero interest and no personal guarantees.
In this case, the ATO has said that, because the loan was not made on normal commercial terms, it would treat the income on the share portfolio as ‘non-arms length income’ of the SMSF causing it to be taxed at the top marginal tax rateYour marginal tax rate is the tax rate that applies to the last dollar of your income. Australia has a progressive tax system where the marginal tax rate applied to individuals increases as your taxable income decreases. Current individual tax rates can be found at the ATO website. (currently 45% plus 2% medicare levy). This applies whether the SMSF is in accumulation or pension mode.
The other decision – ATO ID 2014/40 – applies to the purchase of property. Here, a related party loan was used to fund 80% of the purchase price of a property. The loan term was 15 years (with periodic repayments of principal), no interest was payable and no personal guarantees were given.
The ATO again indicated that income from the property would be treated as ‘non-arms length income’ and taxed at the top marginal rate (plus medicare levy).
Given the difference between the top marginal rate and super fund (or private entity) tax rates, this is likely to be a disastrous outcome for many. So, if you’re using related party loans you need to ensure they are on arms length terms and supported with evidence.
Following the release of the decisions, the ATO also updated its website to provide guidance on how the principles established would be applied to other cases. You can access the guidance here.
Action point: If your SMSF has used a related party loan arrangement ensure you have supporting documentation in place to show that it was made on arms length (commercial) terms or, if it isn’t, you should seek personal advice on your options.
ATO determinations on paying death benefits by journal entries
It’s often difficult or costly to make payments from super funds in cash, especially when it requires the sale of fund assets.
In January, the ATO released two public Interpretative Decisions (ATO ID 2015/2 and ATO ID 2015/3) on whether journal entries (in the books of the super fund) are sufficient to count as a death benefit payment for the purposes of either the Tax Act or SIS RegulationsThe Superannuation Industry (Supervision) Regulations. These contain additional rules that support and expand on the rules contained in the SIS Act..
The decisions are based on a two member (couple) SMSF where one member has passed away. This member’s death benefits are to be paid to the spouse (the other member), who plans to re-contribute the amount to the fund.
To make the death benefit payment in cash requires the sale of listed shares and other investments held in the fund, which would then be re-acquired once the surviving spouse makes their contribution. Simply making journal entries (with no cash transfers) to reflect the death benefit payment and contribution would save the hassle and transaction costs associated with selling assets.
Unfortunately, the ATO view is that death benefits cannot be paid by journal entry. In the case described the SMSF would be required to sell sufficient assets to pay the death benefit in cash to the spouse. The spouse could then contribute this cash to the fund (subject to complying with contributions caps and other rules), where it can then be invested again.
This is a problem for things like listed shares and managed funds, as transaction costs will be incurred. But it’s a potential nightmare where you have long-term deposits and real property since transaction costs are likely to be substantial and the fund is unlikely to be able to re-acquire a property sold to a third party.
Action point: An alternative strategy – best for listed shares, funds, term deposits and other non-property assets – is to make an in-specieA transfer of an asset to satisfy an obligation. In-specie transfers are used as an alternative to selling the asset and paying cash from the proceeds. distribution and contribution of the assets. This minimises the cost of buy/sell spreads, brokerage or early break penalties, although you’ll probably have to pay an off-market transfer fee (around $50) or other transaction costs (check first). Note that for small holdings the transfer fee might be more than the brokerage and any spread you might suffer. Remember, if you’re unsure, seek personal advice before acting.
Court decision: Munro and Munro
In March, the Queensland Supreme Court handed down a decision that highlights just how important it is to make sure your SMSF paperwork is done properly, especially when it comes to estate planning matters.
In the Munro and Munro case, a binding death benefit nominationAlso known as a BDBN. A BDBN is a document given by a super fund member to the super fund trustee. A valid BDBN legally compels the trustee to pay death benefits as directed by the member. form filled out by the deceased member was held not to be a binding death benefit nominationAlso known as a BDBN. A BDBN is a document given by a super fund member to the super fund trustee. A valid BDBN legally compels the trustee to pay death benefits as directed by the member. for the purpose of the fund’s trust deed.
As earlier death benefit nomination forms completed by the deceased were outdated, the invalidity of the last form meant he passed away with no binding instructions on the SMSF trustees. As a result, the remaining trustees were free to act as they saw fit.
There were a number of technical issues considered in the case, but a fundamental problem was that the latest form hadn’t been filled in correctly. The member had written that the trustee was to pay his death benefit to the ‘trustee of (his) deceased estate’.
It is reasonable to assume the member intended for his death benefit to be paid to the executors of his estate, to be dealt with according to his will. However, the form provided clear instructions on how to achieve this – including stating that the death benefit be paid to the member’s ‘personal legal representative’ – and the SMSF’s trust deed required a nomination to be completed in this manner in order to be legally binding. As the form didn’t comply with the trust deed, it wasn’t valid.
The lesson to be learned in this case is that, when it comes to SMSF death benefits, your wishes and intentions count for nought (legally speaking). If you pass away, any surviving trustee is free to make their own decisions as to who gets your super balance, unless they’re legal compelled to act through a binding death benefit nominationAlso known as a BDBN. A BDBN is a document given by a super fund member to the super fund trustee. A valid BDBN legally compels the trustee to pay death benefits as directed by the member. that complies with the trust deed and super laws.
This decision follows an earlier case (Ioppolo & Hesford v Conti) – which has been confirmed on appeal – where a deceased member had very clear wishes but failed to ensure they were documented in a legally correct manner. In that case, her super balance was paid as a death benefit to the person she was seeking to keep it away from.
Action point: Review your estate planning arrangements if you haven’t done so recently. Your fund’s trust deed is the starting point and any instructions you give must comply with it if they’re to be effective. If you want to be confident you’ve got it right, seek legal advice on your overall affairs. Getting your accountant or financial adviser to pull together some paperwork may not be enough.
Other court and tribunal decisions
There have been some other court and tribunal decisions during the year that serve as a reminder of what not to do if you have an SMSF.
In the first decision, an SMSF trustee was ordered to serve 80 hours of community work for failing to lodge annual returns over a number of years, despite reminders to do so. He only narrowly avoided a gaol term.
The second decision (Morrison and Commissioner of Taxation) saw a deposit and loan arrangement involving an SMSF, a Samoan bank and a couple (the fund members) disregarded as a ‘sham’. The couple had their SMSF deposit $600,000 with the bank and then borrowed an identical amount a few days later.
Rather than accepting the transactions on their face, the ATO treated the amount as a withdrawal from the fund and taxed them heavily on the amount, including substantial penalties. With a small exception, the tribunal confirmed the ATO’s decision.
The decision highlights why it’s so important not to play games with self-managed super. The ATO is likely to come down hard on any people or products they don’t see as being within the spirit of the rules.
New superannuation thresholds for 2015/16
The ATO recently updated their website with the latest superannuation caps, rates and thresholds. Key points to note are:
- Contributions Caps. There’s been no change to the general concessional contributions capThe annual cap (for each year ended 30 June) on the amount of concessional (pre-tax or tax deductible) contributions a person is allowed to contribute to super. For more information on cap amounts see the ATO website. ($30,000), the special concessional cap for those aged 49 years or over on 30 June of previous year ($35,000) or the non-concessional cap ($180,000).
- Low Rate Cap Amount. The lump sum low rate cap will jump from $185,000 to $195,000 from 1 July 2015. The low rate cap is the lifetime cap that allows you to withdraw a certain amount of the taxable component of your super tax-free, regardless of your age (assuming you’ve met a condition of release).
- Maximum Super Contribution Base. The maximum amount on which employers are required to make compulsory super contributions will increase to $50,810 per quarter. This means someone earning over the maximum, will have over $19,000 of contributions to super per year before any voluntary contributions are made.
The complete list of updated superannuation rates, caps and thresholds can be found at the ATO website.
Other developments and reading material
Eviser members may also be interested in the following:
- Webinars for SMSF trustees. The ATO now runs webinars for SMSF trustees and superannuation professionals. Recordings of completed webinars are made available on the ATO website.
- SMSF case studies. The ATO publishes case studies for SMSF trustees on its website and has recently published new case studies.
- SMSF questions and answers. The ATO recently published answers to questions raised during recent webinars on super pensions.
- SMSF statistical overview: 2012/13. In January the ATO released the fifth edition of the annual statistical overview of the SMSF sector.
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