SPAA calls for rethink on tax after death

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The Self Managed Super Fund Professionals’ Association (SPAA) has expressed concern about a draft tax ruling which clarifies that income derived from assets supporting the payment of a pension from a superannuation fund are immediately taxable upon the death of the pension member. The draft ruling TR 2011/D3 includes tax liabilities from income taxes and capital gains, and will apply retrospectively from 1 July 2007.

“SPAA believes the retrospective nature of this draft tax ruling on pensions from a super fund following the death of a retired member, is unfair and inequitable and against the spirit of the tax law,” said Sharyn Long, SPAA chairman.

“Take an example of a property that has been held in a fund for many years, the capital gains tax bill could be a substantial part of the superannuation fund balance. If the trustees were not expecting to have to pay capital gains tax because the member is in pension phase, typically no tax contingencies will have been made by the fund for this purpose. This poses questions for trustees and auditors signing off on annual accounts as they must determine the likelihood of the tax payments being due based on future events,” Ms Long said.

“Rulings like this should be forward looking so people can plan ahead for their retirement with confidence and not be afraid of leaving crippling tax bills for their grieving families where a member has died. We hope that the Australian Tax Office will seriously re-consider its position.”

The draft ruling considers when a superannuation income stream commences and when it ceases. According to the ruling, a superannuation income stream ceases when there is no longer a member who is entitled to be paid a superannuation income stream benefit from the fund.  If the fund’s affairs have been set up correctly and the deceased has a surviving spouse or a minor child under age 18, they could receive a reversionary pension without tax penalty.

However, beneficiaries who are not considered financial dependants under the tax law, such as adult children, are not eligible to receive a reversionary pension and must be paid a lump sum. Where a fund is required to sell assets in order to pay a lump sum, capital gains tax may be payable on any capital gains realised at that time. This tax, generally discounted to 10%, but possibly to 15%, would apply on top of the 16.5% tax on the taxable part of the death benefit where the beneficiary is an adult child.

SPAA does not agree with the ATO’s interpretation and believes the income and capital gains supporting the pension should continue to be tax exempt after the date of death.

“The payment of a death benefit is an integral feature of a superannuation income stream contract. To say that the pension ceases before the trustees have satisfied all of their obligations under the pension contract is, in our view, not correct. The industry has always worked on the basis that the trustee’s contractual obligations under the terms of the pension only ceases once the pension death benefit has been paid. Therefore it is reasonable, and arguably what was intended by the policy makers at the time, that the pension tax exemption should only cease at that time,” Ms Long said.

SPAA is also concerned that the ATO interpretation will lead to unnecessary costs and potentially undesirable strategies in an attempt to avoid extra taxes on death. For example, pension members may start withdrawing all of their pension balance before the date of death, or using strategies to refresh the cost base of their superannuation assets.

The draft ruling also applies to pensions that are fully commuted prior to death, saying that the amount payable on the full commutation of a pension should be treated as a lump sum for tax purposes. This position is based on the argument that the superannuation income stream ceases upon receipt of a valid request from a member to fully commute the pension. Therefore, as the payment resulting from the full commutation is made after the cessation of the superannuation income stream, the payment may be subject to capital gains tax even in situations where the amount commuted is transferred to another pension.

“In SPAA’s view, this may create an unnecessary barrier if members want to transfer their pension to another pension provider. Again, we believe the tax exemption should only cease once the trustee’s contractual obligations under the terms of the pension have ceased. This means the tax exemption provided to income on pension assets should cease when the commutation payment is made and not when the commutation request is received,” Ms Long said.

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