Testamentary trusts offer a powerful tool for estate planning, particularly for families looking to protect assets, provide for future generations and optimise tax outcomes.

Despite a perception that the use of trusts is the domain of the extremely wealthy, trusts can be used by a broad spectrum of clients to achieve a range of objectives, including effective tax management. This article, proudly sponsored by Allianz Retire+, examines trusts and tax.

A trust is a legal arrangement in which a person or entity (the trustee) holds and manages property or assets for the benefit of one or more beneficiaries. It is a versatile tool used to manage and protect assets and offers benefits in estate planning and tax optimisation.

While trusts are generally not considered legal entities, they are treated as taxpayer entities for tax administration purposes. Trusts are commonly used for investment, estate planning and business because they provide flexibility and control over how assets are managed and distributed.

Trusts – an overview

A trust is an obligation imposed on a person or other entity to hold property for the benefit of beneficiaries. It should have its own tax file number, which the trustee uses when it lodges income tax returns for the trust. A trust is also entitled to an Australian business number if the trust is carrying on an enterprise.

There are two main parties in a trust, the trustee/s and the beneficiaries. You may also see reference to the settlor, who is the person who creates the trust and transfers property or assets into it.

Key parties and obligations

Trustees can be an individual or a company – known as a corporate trustee – which are responsible for managing the trust’s assets. The trustee must act in accordance with the trust deed and relevant laws, including tax laws. Where the trust is established by a trust deed, the trustee must deal with trust property in line with the intentions of the settlor as detailed in the trust deed.

Under trust law, which is administered by states and territories, trustees are personally liable for the debts of the trusts they administer. They are generally entitled to be indemnified out of the trust property for liabilities incurred in the proper exercise of their powers, except in the situation where a breach of the trust has occurred.

Under tax law, the trustee is responsible for managing the trust’s tax affairs, including registering the trust in the tax system, lodging trust tax returns and paying some tax liabilities.

Beneficiaries are the people or entities entitled to receive the benefits of the trust, such as income or capital. Beneficiaries can be individuals, companies, or even other trusts. The trustee may also be a beneficiary but cannot be the sole beneficiary unless there are multiple trustees.

Tax treatment of trust earnings

For tax purposes, trusts are treated as distinct taxpayer entities. However, the way income is taxed depends on the beneficiaries’ entitlements to that income. Trusts generally distribute their earnings to beneficiaries, and the beneficiaries are taxed on their share of the trust’s net income, regardless of whether they have actually received the income.

The net income of a trust is its assessable income for the year, minus allowable deductions, and it is worked out on the assumption that the trustee is a resident, even if they are not. Because the income of a trust is determined in accordance with the trust deed and the net income is determined in accordance with tax law, the two amounts may differ.

The trustee is responsible for lodging the trust’s tax return and ensuring that the trust complies with tax laws. Special rules apply to certain types of income, such as capital gains and franked distributions.

The beneficiaries are taxed on their share of the trust’s net income. For example, if a beneficiary is entitled to 50 percent of the trust’s income, they will be taxed on 50 percent of the net income of the trust. Beneficiaries may also be entitled to receive franked distributions from the trust. If allowed by the trust deed, franked dividends can be streamed to particular beneficiaries for tax management purposes. For example, franked dividends may be allocated to those beneficiaries with the highest marginal tax rate.

The trustee pays tax on behalf of non-resident beneficiaries and minors. If there is no beneficiary entitled to the income, the trust is taxed at the highest marginal rate applicable to individuals.

Capital gains tax

Trusts also have specific rules related to capital gains tax (CGT). For example, if a trust disposes of an asset and generates a capital gain, that gain is included in the trust’s net income and distributed to the beneficiaries in proportion to their entitlements. In some cases, a trustee can choose to pay tax on a capital gain rather than distribute it immediately to a beneficiary. A net capital loss is carried forward and offset against the trust’s future capital gains.

If there is no beneficiary entitled to income (or specifically entitled to the capital gain) the trustee is taxed on the capital gain. In the situation where the trustee is taxed on trust net income at the top marginal rate, they are not entitled to the CGT discount on the gain.

Important to CGT is the notion of ‘absolute entitlement’. A beneficiary is ‘absolutely entitled’ to an asset of a trust if they have a ‘vested and indefeasible’ interest in the entire trust asset – in other words, they can direct the trustee to immediately transfer the asset to themselves or to someone else.

In the situation where a beneficiary is absolutely entitled to a trust asset, the asset is treated for CGT purposes as if it is owned directly by the beneficiary and not the trustee. Any actions taken by the trustee in relation to the asset are taken to have been done by the beneficiary directly. This means that if a capital gains tax (CGT) event happens in relation to the asset, any capital gain or loss will be made directly by the beneficiary and doesn’t form part of the trust’s net income.

There is also the notion of ‘specific entitlement’. In this situation, a capital gain can be streamed to a particular beneficiary by making them specifically entitled to the gain. In such cases, the capital gain is calculated for the income year with the benefit of any discounts or concessions to which they are entitled.

Tax returns and tax payments

The trustee is required to lodge a trust income tax return, irrespective of the amount of net income involved, unless advised otherwise by the ATO. If the trustee is liable for tax, they will receive an income tax assessment as trustee; this is separate to their own assessment as an individual or corporate tax entity.

The beneficiaries (or the trustee when assessed on their behalf) may have to pay regular tax instalments based on their share of the trust’s instalment income.

Advantages and disadvantages of trusts

The following details some of the advantages and disadvantages of the trust structure but is not an exhaustive list. Specific client circumstances could impact whether certain trust features are advantageous or disadvantageous.

Family trusts

A family trust is a popular legal structure primarily used to manage and protect family wealth, distribute income and for tax planning. When a trust makes a ‘family trust election’, it is recognised as a family trust; this confers certain tax advantages but also specific tax obligations.

How a family trust works

A family trust is typically discretionary, meaning the trustee has the power to decide how to distribute income and capital among the beneficiaries. The beneficiaries are often members of the same family, and their entitlement to distributions is at the trustee’s discretion. This flexibility allows for strategic financial planning, especially in terms of managing tax liabilities.

To establish a family trust, the trustee can be an individual or a corporate entity. Many families prefer appointing a corporate trustee for reasons such as asset protection, limited liability and succession planning. The trust itself is governed by a trust deed, which outlines how the trust will be managed, who the beneficiaries are and how distributions will be made.

The family trust election is a key aspect of this structure. It is a formal declaration made to the ATO that qualifies the trust for specific tax concessions, particularly related to the trust loss provisions. However, this election also means that any distribution made to individuals or entities outside the ‘family group’ may trigger the Family Trust Distribution Tax (FTDT). This tax is levied at the highest marginal rate plus the Medicare levy, making it a significant cost if the trust does not stay within its family group for distributions.

Why use a family trust?

The most common reasons for setting up a family trust include:

• Asset protection: by holding assets in a trust, families can protect them from potential creditors or legal claims against individual family members. If a family member faces financial difficulties, the assets held by the trust are not considered part of their personal estate which provides a level of legal insulation.
• Tax planning: family trusts offer considerable flexibility when it comes to tax planning. By distributing income to beneficiaries with lower marginal tax rates, families can minimise the overall tax burden. For example, a trustee might allocate more income to a beneficiary who earns less or is not employed.
• Investment and business planning: many families use trusts to hold investments or business assets. For instance, if a family trust owns a commercial property, the rental income can be distributed in a tax-efficient way. Family businesses are often structured as trusts, offering both asset protection and tax benefits.
• Succession planning: a family trust can be an effective tool for estate and succession planning. Rather than transferring assets directly to heirs, which could trigger capital gains tax (CGT) or stamp duty, the assets remain in the trust, allowing beneficiaries to continue to enjoy the benefits, such as income from shares or property investments.

Advantages and disadvantages of family trusts

As with trusts more generally, specific client circumstances could impact how advantageous or disadvantageous certain family trust features are

Family trusts are an effective tool for tax planning, asset protection and succession planning. They give trustees the flexibility to manage income distributions in a tax-efficient manner and offer advantages that other structures may not. However, family trusts can also present challenges, particularly when it comes to tax obligations, potential family conflicts and handling undistributed income. To ensure the trust meets its objectives and adheres to legal regulations and tax obligations, careful planning and management are crucial.

Testamentary trusts

A testamentary trust is established through a will and only comes into effect after the will-maker, or testator, has passed away. Its main function is to control how assets from the deceased’s estate are distributed to beneficiaries.

Unlike a standard bequest where assets are handed directly to the heirs, a testamentary trust holds these assets in trust, with the trustee responsible for managing and distributing them according to the terms of the will. This structure provides certain legal, financial and tax advantages that make it an attractive option for estate planning.

How does a testamentary trust work?

The creation of a testamentary trust occurs upon the death of the testator and after the estate administration has been completed. Assets from the estate are transferred into the trust, and the trustee manages them for the benefit of designated beneficiaries. These beneficiaries can include minor children, family members with specific needs, or even individuals who require financial protection.

Testamentary trusts can be either fixed or discretionary. In a fixed trust, the amount each beneficiary receives is predetermined. A discretionary testamentary trust more commonly used because it provides the trustee with the flexibility to distribute income and capital among beneficiaries based on their needs and tax circumstances. This flexibility makes discretionary trusts particularly useful for tax planning purposes.

Why use a testamentary trust?

Testamentary trusts are primarily used to manage how assets are distributed to beneficiaries after death, but they serve several key purposes:

• Tax efficiency: testamentary trusts can provide significant tax advantages, particularly when distributing income to minors. Normally, income distributed to children under the age of 18 is taxed at penalty rates to prevent parents from diverting income to lower-tax-rate children. However, testamentary trusts are an exception to this rule and minors who receive income from a testamentary trust are taxed at adult tax rates, which are typically much lower, and use can be made of the tax free threshold. This provision allows families to reduce the overall tax burden on estate income and improve tax efficiency across family members.
• Asset protection: a testamentary trust can protect estate assets from creditors, legal disputes and family law claims. Because the beneficiaries do not have direct ownership of the trust’s assets – only an entitlement to income and distributions determined by the trustee –those assets are often shielded from legal action taken against the beneficiaries, such as bankruptcy or divorce settlements.
• Control over asset distribution: testamentary trusts allow the testator to retain control over how and when assets are distributed to beneficiaries. This is particularly useful for ensuring that minors or financially irresponsible heirs do not receive large sums of money all at once. The trust can specify conditions for when beneficiaries can access their inheritance, such as reaching a certain age or meeting particular milestones, such as completing tertiary education.
• Long-term estate management: where the estate includes significant assets that require ongoing management, such as investments or property, a testamentary trust can ensure these assets are managed professionally and in the best interests of the beneficiaries. The trustee – who may be a family member, professional adviser or financial institution – oversees the investment and distribution of trust assets in accordance with the testator’s wishes.

Tax effectiveness

One of the most compelling reasons to establish a testamentary trust is the tax efficiency it can offer. Testamentary trusts allow for income splitting among beneficiaries, particularly those in lower tax brackets, thereby minimising the overall tax paid on estate income. By distributing income to beneficiaries based on their personal tax rates, the trustee can reduce the tax burden on the estate.

As indicated above, a notable tax advantage of a testamentary trust is the concessional treatment of income distributed to minors. Normally, income received by minors from trusts is taxed at penalty rates; however, income distributed to minors from a testamentary trust is taxed at the same rates as adults, which allows families to make use of lower marginal tax rates to their advantage. This can significantly reduce the tax on income derived from assets within the trust, such as rental income or investment returns.

However, it’s important to note that tax concessions are limited to income generated by assets directly transferred into the trust from the deceased’s estate. Income from assets introduced to the trust from external sources, such as gifts or loans, does not qualify for these tax benefits and will be taxed at the higher penalty rates for minors.

Advantages and disadvantages of testamentary trusts

As with trusts more generally, specific client circumstances could impact how advantageous or disadvantageous certain testamentary trust features are.

Testamentary trusts offer a powerful tool for estate planning, particularly for families looking to protect assets, provide for future generations and optimise tax outcomes. However, they require careful planning and consideration to ensure that they are the right solution for each particular family’s needs.

All trusts come with significant legal and tax obligations that must be carefully managed. Trustees have a fiduciary duty to act in the best interests of the beneficiaries, while beneficiaries have an obligation to report their share of the trust’s income for tax purposes. In the event a client wishes to establish a family or testamentary trust, the decision should always be guided by your professional advice – or that of other specialists you may call on – to navigate the complexities and ensure compliance with legal and tax requirements.

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Notes:
[1]  ATO, Deceased Estates
[2] ATO, Inherited Property and CGT

The post Tax and Trusts appeared first on AdviserVoice.

Tax, as it pertains to deceased estates, involves certain steps that clients need to take to finalise tax matters for family members or, in some cases, advisers for their clients.

Everyone knows the famous Benjamin Franklin quote about death and taxes, but not everyone is aware that tax obligations continue after death. This article, proudly sponsored by Allianz Retire+, examines these obligations and other tax matters that affect a deceased estate.

In the last article in this series, we examined Estate planning and tax and the measures clients can consider when preparing their estate, particularly as it relates to minimising tax for beneficiaries. However, while it might be expected that tax obligations effectively end with death, that is not the case. And, while Australia has not had a formal inheritance tax (in the form of death duties) since 1979, bequests are not always received tax free.

Death and tax – obligations

The ATO works on the assumption that a deceased estate will continue to earn income after death. This income might arise from interest, dividends or rent from property investments. It’s a requirement that any tax obligations are finalised before the assets of an estate are distributed.

If a client is administering an estate, they need to understand their obligations under tax law. These are to^[1]:

• notify the ATO of the death so it ceases any correspondence re tax matters
• determine whether they need a grant of probate or letters of administration.

One of these court-issued documents is required to be considered the authorised legal personal representative (LPR) by the ATO, and thereby be granted full authority to manage the deceased’s tax affairs and have unrestricted access to ATO-held information and assets of the estate.

One of these documents is generally required to manage other aspects of a deceased estate; this may vary according to law in the relevant state or territory.

• The ATO must be notified as to who is managing the estate; this is done by submitting an official notification of death. The ATO will add the LPR’s name to the estate’s records.
• If the deceased person’s tax affairs included running a business, business tax obligations must be managed.

If the deceased person was a sole trader or in a partnership, a final business activity statement (BAS) for the last tax period may need to be lodged. This is usually the quarter in which the person died and the period ends the day before their death. Any outstanding BAS will need to be lodged and tax paid.

Goods and services tax (GST) and capital gains tax (CGT) may apply to the sale of any assets used in the business.

• check to see whether a final tax return for the deceased needs to be lodged. This is called a ‘date of death’ tax return and covers the income year in which the person died, up to the date of death.

A date of death tax return must be lodged if any of the following applied to the deceased in the income year in which they died:

• they had tax withheld from their income, including from interest, dividends or rent
• their taxable income was above the tax-free threshold
• they lodged tax returns in the income years before their death or have outstanding tax returns.

The deceased’s date of death tax return should include:

• any salary earned up to the date of death
• investment income earned up to the date of death
• capital gains where the agreement to sell was made prior to death
• any taxable superannuation income received up to the date of death.

Any outstanding tax returns must also be lodged and where applicable, tax paid to the ATO.

If a date of death tax return is not required, a non-lodgement advice form must be completed and provided to the ATO.

• Tax returns for the deceased estate, called a trust tax return, must be lodged for each year. This traverses the income year in which the individual died, through to the year the estate is finalised, and assets distributed to beneficiaries. The first income year of a deceased estate starts the day after the date of death and ends on the following 30 June.

The trust tax return should include:

• any salary earned after death
• investment income after death; this should include income earned from assets such as dividends, interest or rent
• capital gains on assets sold by the estate
• deductions for expenses incurred by the estate related to earning income.

The deceased estate is deemed to be a separate entity to the deceased individual, hence the need for separate tax returns.

You can lodge a trust tax return even if it is not required. For example, your client may wish to lodge a return to claim franking credits on dividends paid to the estate.

A note on capital gains and losses; capital gains are still taxable after death, but capital losses die with the deceased. In the event a client’s death is anticipated, a strategy to sell assets carrying unrealised gains to use capital losses being carried by the client might be considered.

Death and the family home

Although Australia officially abolished death duties in 1979, the family home is a substantial asset in most estates and one that may attract capital gains tax (CGT). Its tax treatment is dependent on several factors, the most important being whether the home is a pre-CGT asset (bought prior to 20 September 1985) or acquired after that date. Other impacts arise from whether the home is covered – in full or in part – by the main residence CGT exemption, and how the title is held.

If the deceased purchased the property before 20 September 1985 and is inherited after this date, the property is valued at its market value at the date of death of the property owner and beneficiaries generally have two years to sell the property to qualify for a CGT exemption.

If the home is a post-CGT asset, the beneficiaries inherit the property at market value at the date of death if it is covered by the main residence exemption at the time of death. ​The main residence CGT exemption applies if^[2]:

• the home was the deceased’s main residence before death and was not being used to produce income, and
• the home was sold and settled within two years of the person’s death (although this timeframe can sometimes be extended at the discretion of the ATO), or
• from the deceased’s death until disposal, the dwelling is not used to produce income and is the main residence of one or more of:
  • the spouse of the deceased immediately before the deceased’s death,
  • an individual who had a right to occupy the dwelling under the deceased’s will, and
  • a beneficiary, if disposing of the dwelling as a beneficiary.

If the property is not or only partially exempt from CGT, the beneficiary needs to know its cost base to determine the capital gain. If the property is partially exempt from CGT, the beneficiary needs determine the proportion of the property that is exempt.

In the case where land was purchased before 19 September 1985, but a home built on the property after that date, the property is treated as two separate assets; the land is treated as a pre-CGT asset and the home as a post-CGT asset.

Ownership through company or trust

If a client owns (or inherits) a home through a company or trust, death does not affect the ownership of the home – the entity that owns the home has not died. If the deceased holds units in a trust or shares in a company that owns the home, the estate has to manage the ownership of those units or shares. Where clients have a company or trust, their estate planning should include the transfer of those units or shares.

It’s important to know that holding the family home in a company or trust will prevent your clients’ estate from benefiting from the main residence CGT exemption.

Death and super

Like the family home, superannuation is often a major estate asset…however, super death benefits don’t automatically form part of a deceased member’s estate. This is because super isn’t considered to be a personal asset that’s owned in the client’s own name; it’s held in trust by the super fund’s trustees.

In the majority of cases, the super fund’s trustees pay the death benefits directly to the deceased’s dependants or beneficiaries as defined in a binding death benefit nomination. In this case, those death benefits do not form part of the estate.

In some cases, the fund trustees may pay the death benefits, in full or part, to the estate’s executor, in which case the superannuation death benefits do form part of the estate and are distributed in accordance with the deceased’s will. Clients may make a valid binding nomination in favour of the estate rather than individual/s if they wish their super death benefit to form part of their total estate.

The distribution of super death benefits depend on a number of factors: the terms of the fund’s trust deed, applicable legislation and any valid beneficiary nomination made by the deceased.

Superannuation lump sum death benefits are tax free if paid to a “death benefits dependant” for tax purposes. A “death benefits dependant” is defined as:

• the deceased persons current or ex-spouse or de facto spouse
• the deceased persons child aged under 18 years of age
• any other person with whom the deceased had interdependency relationship.

Any other person who the deceased person had an interdependency relationship with just before they died, or anyone dependent on the deceased person just before their death is also considered to be a “death benefits dependant”.

The definition of a “death benefits dependant” under taxation law (in other words, who can receive a tax free death benefit) is slightly different to the definition of a “dependant” under superannuation law.

If superannuation death benefits are paid directly by the super fund trustee to a dependent who is not considered a death benefits dependent (e.g. a child over 18 who was not financially dependent on the deceased at the time of death), the trustee is responsible for calculating and withholding any applicable superannuation death benefits tax from the payment.

The tax on a super death benefit depends on:

• whether the recipient was a dependant of the deceased under tax law
• whether it is paid as a lump sum or income stream
• whether the super is tax-free or taxable
• the recipient’s age and the age of the deceased person when they died (this is relevant to income streams).

Tax is only paid on the taxable component of the benefit; money contributed as concessional contributions and fund earnings. Non-concessional contributions comprise the ‘tax-free’ component. If tax does apply, it is levied at a maximum of 17% (15% plus Medicare levy). If the deceased was under 65 at the time of their death, some of the taxable component may be taxed at a rate up to 32% (including Medicare levy).

In the situation where death benefits are paid to the legal personal representative (such as the executor), the trustee does not deduct tax. Instead, they provide the estate’s representative with a statement detailing the taxable components of the payment. It is then the responsibility of the legal representative to pay any super death benefits tax from the estate before it is distributed.

If superannuation death benefits are paid to the legal personal representative and then to a death benefits dependant, no tax will be payable.

Self-Managed Super Funds

For those clients with an SMSF, consideration needs to be given to who will control their SMSF when they die. This is because the person in control of the SMSF may, subject to any binding death benefit nomination, have the ability to deal with the deceased member’s death benefits as they choose.

When creating an estate plan for clients with an SMSF, it is important to:

• ensure the estate plan transfers control of the SMSF, including the power to pay death benefits, in line with the client’s wishes
• consider whether a binding death benefit nomination should be made.

When an SMSF member dies, the SMSF generally pays a death benefit to a dependant or other beneficiary of the deceased.

If the death benefit is paid as a lump sum to a death benefits dependant of the deceased, it’s tax free and not considered assessable or exempt income. The SMSF doesn’t withhold tax from the payment and the recipient don’t include it in their income tax return.

If the death benefit is paid as an income stream and is paid to a non-dependent or the trustee of a deceased estate, there may be tax to pay. The SMSF will need to determine the taxed and untaxed elements of the benefit, calculate the applicable tax and, if appropriate, withhold tax from payments.

Bequests and tax

While there may be no inheritance taxes in Australia, beneficiaries may have tax obligations for the assets they inherit. Capital gains tax may apply if a client disposes of an asset inherited from a deceased estate (but not the family home if disposed of within two years).

Income producing assets, such as cash, shares and property attract no tax on the value of the asset itself, only on the income derived from it. If a client inherits shares, they will be required to pay tax on the dividends received. Similarly, inherited property attracts income tax on rental income and cash on interest income. Tax payable is generally calculated from the date of death of the person bequeathing the asset.

Dealing with a deceased estate is much more than simply dividing up assets. Clients preparing their estate – or preparing to administer an estate – need to be aware of the myriad of obligations that follow death. A sound estate plan, with thought given to the administration of that asset and taking measures to minimise the tax liabilities for beneficiaries can smooth the process for intergenerational wealth transfer. The Productivity Commission’s 2021 report highlights an expected A$3.5 trillion intergenerational asset transfer in Australia by 2050, making estate and related tax planning an integral part of the advice process.

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Notes:
[1]  ATO, Deceased Estates
[2] ATO, Inherited Property and CGT

The post Deceased estates and tax appeared first on AdviserVoice.

What are the tax consequences that flow from estate planning?

Estate planning is a fundamentally important aspect of financial (and legal) management – and has important tax consequences. This article, proudly sponsored by Allianz Retire+, examines some of the elements of estate planning and the tax consequences of each.

Estate planning is often viewed as a way to ensure that assets are distributed according to one’s wishes after death, but its significance extends beyond that. One of the most critical yet frequently overlooked aspects of estate planning is its role in effective tax management. Properly structured, an estate plan can help individuals and families navigate the complexities of wealth transfer, minimise tax payable by beneficiaries, consider any social security impact and ensure that a financial legacy is passed on efficiently.

To this end, estate planning is as relevant for a business as for individuals. For without thoughtful tax planning, a significant portion of an estate (business or personal) can be eroded by taxes, leaving beneficiaries with far less than intended.

When working with clients on estate planning, there are several important things to bear in mind.

Firstly, estate planning laws vary by state; therefore it’s important to understand the law as it pertains to your (and your client’s) locale.

Secondly, an estate lawyer is best placed to advise on and create relevant estate planning documents; this includes the Will and any Powers of Attorney.

Finally, your client’s circumstances may change, so the estate plan should be regularly reviewed to ensure that it’s up-to-date and reflects any changes to their personal situation. A marriage or divorce, the purchase or sale of a business, births and deaths…each of these events can necessitate a review of a client’s estate plan.

Ultimately, an effective estate plan will ensure that the ownership of assets passes to the correct beneficiaries, any payable tax is minimised, and the assets are protected if there is a legal dispute.

Key components of an estate plan

A comprehensive estate plan encompasses several elements to ensure your client’s wishes are honoured and their assets effectively managed:

• Will – the foundation of any estate plan, the Will details how your client’s assets should be distributed after death. It also designates an executor responsible for administering your client’s estate according to their specified wishes.
• Super – your client needs to make binding death nominations for super. The allocation of super is managed by the fund’s trustee and can’t be distributed via a client’s will. Binding and non-binding super beneficiaries will receive any unspent super money from the trustee.
• Power of Attorney – this allows your client to appoint a trusted individual to manage their financial and legal affairs in the event they become unable to do so themselves. An Enduring Power of Attorney is a specific type of POA that remains in effect if the client becomes incapacitated or unable to make decisions.
• Enduring Guardianship – in some jurisdictions, a medical Power of Attorney is granted, in others, an Enduring Guardianship grants a designated person the authority to make decisions regarding your client’s health and lifestyle if they become unable to do so.
• Advanced Care Directive – sometimes referred to as a Living Will, this document enables your client to outline their preferences for medical treatment and end-of-life care in situations they are unable to communicate their wishes.
• Trusts – a legal arrangement in which a trustee manages assets on behalf of beneficiaries, with distribution occurring at a predetermined time. Trusts can offer tax advantages and protect assets; an example is the establishment of a trust for a child that becomes accessible at a specific milestone birthday or other point in time.

All legal documents are best created by an estate lawyer. There are also a range of legal implications to consider:

• All estate planning documents must meet the legal requirements for validity. This includes compliance with relevant legislation, which varies by state or territory.
• Understanding the tax consequences of asset transfers is an essential part of estate planning. You need to consider capital gains tax, stamp duty and income tax, each of which can significantly impact the value of assets passed to beneficiaries.
• Legal capacity is important to avoid potential challenges to the Will in the future. Your clients need to create a Will at a time they have the legal capacity to do so. No-one expects to lose capacity, but steadily increasing dementia rates means that statistically, it’s likely it will affect some of your clients (note: it is estimated that more than 421,000 Australians are living with dementia in 2024, a figure likely to rise significantly without medical breakthrough)^[1].

The Will

The Will is the cornerstone of estate planning. It serves as the primary legal document that outlines how a client’s assets should be distributed upon death, or in some cases, permanent incapacitation.

A Will ensures that your client’s wishes are clearly stated and legally enforceable, helping to avoid potential disputes among beneficiaries.

The functions of a Will include:^[2]

1. Appointing someone to administer the estate after death
2. Recording how assets are to be distributed after death
3. Fulfilling financial responsibility after death – discharging debt and looking after dependents
4. Revoking/cancelling old wills
5. Establishing a trust for beneficiaries

A Will plays other important roles. It enables clients to appoint a guardian for minor children, name an executor to manage their estate and make specific bequests to individuals or charities. By formalising these decisions in a Will, your client takes control of their legacy.

Clients may hold two types of assets: estate assets and non-estate assets. The former includes any asset the client owns in their own name. Non-estate assets include those owned as a joint tenant, in a trust or in superannuation. Life insurance is also generally disposed of according to specific rules and not distributed via the Will.

Without a Will, a client’s estate may be distributed according to state intestacy laws, which may not align with your client’s preferences. In the case of intestacy, there’s a risk that the undocumented intentions of the client in relation to their estate may not be acted on. Further, depending on the marginal tax rates of the beneficiaries, intestacy can lead to an imbalance in the distribution of an estate due to higher rates of tax payable by some beneficiaries.

Intestacy can also reduce the size of your client’s estate thanks to other charges; administering an estate is more expensive when outside parties must be involved and compensated for their services. The family can generally expect to pay the government more revenue, in the form of legal and other fees, capital gains tax and income tax.

Powers of Attorney

While a Power of Attorney (POA) won’t impact the tax implications of estate planning, it’s good form for clients to nominate a power of attorney while they are preparing their Will. As with Wills, each state has its own legislation in respect to POAs.

A POA is a separate legal document which enables your client to appoint one or more people to manage their financial and legal decisions on their behalf while they are alive. A POA ceases upon death.

An Enduring Power of Attorney (EPA) can be used to make decisions for your client in the situation they are unable to do so, if for example, they lose capacity. An attorney is legally required to act in your client’s best interests; therefore, the appointment of a trusted person to as POA can ensure your client’s affairs are managed as they would like them to be in the event they become incapacitated before death.

An EPA is of particular importance to clients with a self-managed super fund. Regulations require all members of an SMSF to be trustees, but a person without capacity is prohibited from being a trustee. In the situation where a trustee of an SMSF loses capacity – whether your client or a non-client member of a client’s SMSF – decisions about the SMSF would have to be made by a tribunal if there is no EPA in place for that member. It’s good form to ensure that all SMSF clients have EPAs in place – and that all members of their SMSFs do too.

Superannuation

As a non-estate asset, superannuation is treated differently to other investments. Because it’s managed by the trustee of your client’s fund, it can’t be incorporated into or distributed by their will.

There are four important considerations when estate planning for client’s superannuation^[3].

1. When a super fund’s member dies, the money is paid out of the fund
2. Only certain people (i.e. nominated beneficiaries) are eligible to directly receive a superannuation death benefit
3. Insurance proceeds inside a super fund may be heavily taxed on the member’s death
4. In some circumstances, there can be a death tax on super; there are strategies to minimise this or for beneficiaries to avoid becoming eligible to pay it.

Your client needs to nominate superannuation beneficiaries who will receive any remaining super once your client passes away. There are two types of beneficiaries: binding and non-binding beneficiaries.

A binding death benefit nomination is a written declaration your client provides to their fund. This provides a legal obligation for the trustee to distribute your super to those people nominated by the client. Binding nominations are generally required to be validated every three years to remain binding.

A non-binding nomination is the preferred choice of beneficiary that your client selects, the difference being that the super trustee is not obligated to follow it. When distributing your remaining super, the trustee will take your non-binding nomination into account, along with the claims of other dependants.

In both cases, trustees must follow the relevant super laws. Beneficiary nominations are made available so clients have the opportunity to legally ensure their chosen beneficiaries receive payment, even where there may be claims over your client’s estate after their death.

When it comes to super and tax, there’s a difference between SIS-dependent beneficiaries and tax-dependent beneficiaries; in super law it defines who can receive death benefits, in tax law, if and how a recipient will be taxed.

A SIS-dependent beneficiary indicates the beneficiary meets the rules to receive the death benefit under the SIS Act 1993.

A tax-dependent beneficiary includes a former spouse and children under 18. They can generally receive death benefits tax-free. Non tax-dependents, including adult children, pay tax on the taxable component of any death benefit received from their parents’ super.

A client can nominate an eligible dependant, such as their spouse, to continue receiving an income stream rather than a lump sum payment. This is called a reversionary pension and only applies to super savings already in pension mode.

From a tax perspective, there are several benefits:

• A super pension is generally tax free or in some cases, concessionally taxed, depending on your client’s age and the age of their beneficiary. Consequently, there may be tax benefits for the reversionary beneficiary.
• Because the assets supporting the pension payments remain within the super system, they continue to benefit from super’s lower tax environment.
• When the reversionary pension reverts to the beneficiary, the taxable and tax-free components that were calculated when the pension first started are preserved.

Where life insurance is held within super, any proceeds are paid as part of the superannuation death benefit to beneficiaries. As such, tax will be payable by those beneficiaries who are not tax-dependents.

Testamentary Trusts

A testamentary trust can play a major role in the estate planning process and is usually created when your client drafts their Will. It is written into the client’s Will and is dormant until the client’s death.

Administered by a trustee, a testamentary trust enables your client to leave money to beneficiaries who have use of that money – often subject to certain conditions – but it’s not their own property. This is a strategy commonly used to provide protection against relationship breakdowns, creditors, poor decision making and potential legal issues.

Clients may consider a testamentary trust in circumstances such as:

• They wish to protect their assets for future generations. For example, your client’s beneficiaries can benefit from assets such as an investment portfolio or family business, while the trustee controls how they’re managed. In this scenario, the assets are protected from potential legal action or actions of individual beneficiaries that could otherwise impact them.
• A client has a blended or complex family structure. Numerous scenarios can be modelled by the trustee to preserve assets or to ensure the relevant beneficiaries can access assets in the trust if others pass away.
• Your client needs to protect vulnerable beneficiaries, such as a disabled child. A trust can ensure they don’t lose this inheritance to creditors or that funds are used in their best interests. For those with young children, a trust can hold assets and/or manage assets until the children are old enough to do so themselves.
• Depending on assets held, a testamentary trust can provide tax benefits for your beneficiaries.

From a tax perspective, income generated by a testamentary trust is taxed at the marginal tax rate of the beneficiary of that trust. A testamentary trust also facilitates income splitting, where a beneficiary can allocate trust income to other beneficiaries. This strategy enables beneficiaries with lower marginal tax rates to receive income and pay tax at their lower rate.

Further, minors (children under 18) who receive ‘unearned income’ are generally taxed at the highest marginal tax rate (although the first $416 is tax free). This is not the case with income received from a testamentary trust. Tax law provides that income and capital gains derived by children under age 18 from assets received from a testamentary trust are ‘excepted trust income’ and taxed at normal adult marginal rates.

This means a minor receiving income from a testamentary trust has a tax-free threshold of $18,200 before being taxed at the usual adult marginal rate, depending on the level of income. Imputation credits relating to franked dividends received can be used by the minor.

One of the main advantage of using a testamentary trust for bequeathed assets is that income, capital gains and franked dividends can be distributed among your client’s family beneficiaries each year in the most tax-efficient way.

A major part of estate planning is considering the tax implications for client’s beneficiaries and minimising the tax on their estate. Capital gains is triggered when an asset is sold or gifted. The ATO deems any gift your client makes as a sale at the current market value.

Therefore, good record keeping is essential. For example:

• Knowing what assets were acquired pre-CGT and which may attract capital gains tax.
• Is the family home a pre or post-CGT asset and would it be wholly or partly covered by the main residence CGT exemption?
• Most clients can reduce taxable capital gains by claiming expenses but require records to substantiate any such claims.
• Assets acquired pre-CGT (prior to 20 September 1985) may not be subject to capital gains, however your client needs records to prove the asset is a pre-CGT asset.
• Changes to holdings in shares and managed funds that might arise because of dividend reinvestment, merger and acquisition activity, bonus issues and so on. Again, knowing which are pre and post-CGT holdings is important.

Estate planning is a vital process that goes beyond simply dictating the distribution of assets after death; it plays a critical role in tax management, asset protection and ensures that your clients’ wishes are fully honoured. By carefully considering the various components of an estate plan, your clients can ensure that their financial legacy is preserved, tax liabilities are minimised, and their loved ones provided for according to their intentions.

As personal circumstances evolve, it’s crucial to regularly review and update your clients’ estate plans to reflect any changes. By doing so, your clients can mitigate risks such as disputes, unnecessary taxes or the unintended consequences of intestacy. Estate planning is not a one-time task but an ongoing process that ensures peace of mind for your clients and their families, securing their financial legacy for generations to come.

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Notes:
[1] https://www.dementia.org.au/about-dementia/dementia-facts-and-figures
[2] Wills, death and taxes made simple, Noel Whittaker, 2024
[3] Ibid

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What are the mechanisms through which clients can engage in philanthropy and the tax benefits that arise from these actions?

Philanthropy has a double benefit; it plays an important role by supporting charities, not-for-profits and community groups and comes with tax benefits for the benefactor. This article, proudly sponsored by Allianz Retire+, examines the benefits of philanthropy.

Philanthropy plays a vital role in Australia. It supports a diverse range of charities, not-for-profits and community groups that form our ‘social capital’. This strengthens communities right across our nation. There is a growing need for giving; government funding is generally not tailored and inflexible, and doesn’t always deliver support where it’s most needed. The uncertainty prevailing in today’s economic environment sees increased competition for government support at federal and state levels, which may leave many critical charitable and not-for-profit organisations underfunded. Without the generosity of Australians, many of these organisations would be unable to operate.

That Australians are generous is not up for debate.

The Charities Aid Foundation has been producing its World Giving Index for more than a decade; it’s most recent index showed that Australia is the fourth most generous country in world, with 64 percent of our population donating money^[1].

In Australia, there many ways people can be involved in philanthropy. It can be as simple as making regular donations to charities; these donations are tax deductible as long as the recipient organisation has been endorsed as a deductible gift recipient (DGR) by the Australian Tax Office. Of note is fewer than half of Australia’s charities have DGR status.

Being a deductible gift recipient allows donors to make tax-deductible donations to a charity. This means that donors can deduct the amount of their donation from their own taxable income when they lodge their tax return.

At the other end of the spectrum, individuals or family groups can establish a private foundation, such as a Private Ancillary Fund, a Charitable Endowment Fund, or contribute to a Public Ancillary Fund. These entities generally involve larger donations and make large multi-year grants to charitable organisations. As with simple donations, if the recipient organisation has DGR status, tax deductions are available. This is explored in greater detail later in the article.

Philanthropic giving

Philanthropy is the ‘planned and structured giving of time, information, goods and services, influence and voice as well as money to improve the wellbeing of humanity and the community’^[2]. Most commonly, the focus is on the use of money to support charitable causes. It plays an important role in Australia by supporting a diverse range of not-for-profit organisations and community groups.

Using private wealth for the betterment of the public serves our community. It aids the less fortunate, fosters cultural enrichment and safeguards our environment. It reinforces endeavours that tackle the root cause of social and environmental issues. Importantly, it fills needs that governments are unable or unwilling to fill.

Private Ancillary Funds

A Private Ancillary Fund (PAF) is a charitable trust established by individuals, families or corporates to facilitate philanthropic giving. PAFs are structured to receive and distribute funds for charitable purposes, with the primary goal of providing long-term support to eligible charitable organisations and projects and make a positive impact on society. There are currently around 1,650 such Private Ancillary Funds in operation^[3].

The key features of a PAF include:

Private control: The fund is controlled and managed by the trustees, who are typically the donors or their nominated representatives. This allows the donors to have a significant say in how the funds are invested and distributed.

Sustainable giving: The charity or causes supported by the PAF can benefit from the foundation in perpetuity.

Create a legacy: Individuals and family groups can create a giving tradition and name the PAF in honour of family or in memory of a loved one. A PAF can operate in perpetuity, ensuring the funds invested continue to be used for the intended purpose.

Investment growth: PAFs are structured to invest their funds in order to generate income and grow the capital over time, thereby increasing the impact of their charitable giving.

Distributions: PAFs are required to distribute a minimum of 5% of their net assets each year to eligible charitable organisations and projects.

Regulation: PAFs are regulated by the Australian Taxation Office (ATO) to ensure compliance with the relevant laws and regulations governing charitable trusts and philanthropic giving.

Tax benefits: As long as the PAF is a registered DGR, contributions made to it are tax-deductible for the donor, providing a financial incentive for philanthropic giving. Investment earnings are income tax exempt and franking credits are reclaimable.

To be endorsed under the DGR category for PAFs, the fund must meet all the following requirements:

• have an Australian business number (ABN)
• be in Australia
• comply with the rules in the Private Ancillary Fund Guidelines 2019 and all the trustees of the fund must comply with these rules
• have acceptable rules for the transfer of surplus gifts and deductible contributions on winding-up or revocation of endorsement
• apply to the ATO for endorsement as a DGR.

A PAF is entitled to receive income tax deductible gifts from the date its DGR endorsement starts and while it is endorsed. Tax deductions for gifts to a DGR are claimed by the person or organisation that makes the gift (the donor).

During each financial year, apart from the year the fund is established, a PAF must distribute at least 5% of the market value of the fund’s net assets (as at the end of the previous financial year).

The fund must distribute at least $11,000 – or the remainder of the fund if that is worth less than $11,000 – during that financial year, if both of the following applies:

• the 5% is less than $11,000
• any of the expenses of the fund in relation to that financial year are paid directly or indirectly from the fund’s assets or income.

The ATO can apply penalties for failing to meet minimum annual distribution requirements; however, a PAF can apply to reduce the minimum annual distribution rate.

A PAF might be a suitable philanthropic option for clients who:

• want control over the choice of organisations they support
• would like to provide a sustainable gift to a chosen cause(s)
• have a recommended minimum of $500,000 for an initial donation.

There are several favourable tax advantages applicable to PAFs. Over the longer term, these tax benefits can increase the amount available to distribute to the selected charities.

Tax deductibility: as long as the PAF has DGR status from the ATO and meets its obligations, all donors to the PAF receive a full tax deduction for every dollar donated.

Flexibility to spread deduction: for a donation of cash, publicly listed shares or other property worth more than $5,000, the donor is able to claim a tax deduction over a period up to five tax years. This enables to the donor to claim the tax deduction in a manner that best suits their individual circumstances.

Imputation credits: The tax-exempt status of a PAF means imputation tax credits can be claimed as a rebate from the ATO for any franked dividends received.

Testamentary trusts

As part of estate planning, individuals can establish a testamentary trust to support nominated charitable endeavours. This is established by the will of the benefactor and does not come into operation until after the individual’s death.

The will or trust deed can nominate family members and colleagues to be initial trustees and can specify appointment processes and other requirements of trustees in perpetuity. The trustees are responsible for and control governance, compliance, investments and giving strategies.

A testamentary trust can attain income tax exemptions, but donations are not tax deductible. Testamentary trusts must use their income to fund the charitable purpose as specified in the individual’s will.

Subject to the terms of the will, a donation to an existing DGR approved PAF through an individual’s will removes capital gains tax on any assets donated. This increases the value of the foundation, allowing it to provide more support for the individual’s chosen charities.

Public Ancillary Funds

A Public Ancillary Fund (PuAF) is a type of charitable trust that is established for the purpose of distributing funds to eligible charitable organisations and projects. Unlike Private Ancillary Funds, which are controlled by individual donors or families, Public Ancillary Funds are established for public benefit and are open to receiving donations from the general public.

Key features of a Public Ancillary Fund include:

Public benefit: PuAFs are established for the public benefit and are designed to receive contributions from multiple donors, rather than being controlled by a single individual, family group or organisation.

Support for charitable causes: PuAFs are required to distribute a minimum of 4% of their net assets each year to eligible charitable organisations and projects. These distributions support a wide range of charitable purposes, including (but not limited to) health, education, social welfare, environmental conservation and the arts.

Investment growth: PuAFs are structured to invest their funds in order to generate income and grow the capital over time, thereby increasing the impact of their charitable giving.

Regulation: PuAFs are regulated by the Australian Taxation Office to ensure compliance with the relevant laws and regulations governing charitable trusts and philanthropic giving.

Governance: The management and governance of a PuAF is typically overseen by a board of trustees or directors, who have a fiduciary duty to manage the fund prudently and in accordance with the fund’s charitable objectives.

Tax deductibility: Contributions made to a PAF are tax-deductible for the donor, as long as the PuAF is a registered DGR. This provides a financial incentive for philanthropic giving.

For a PuAF to be endorsed as a DGR it must meet the following requirements:

• have an Australian business number (ABN)
• be in Australia
• comply with the rules in the Public Ancillary Fund Guidelines 2022; all of the trustees of the fund must comply with these rules
• have acceptable rules for the transfer of surplus gifts and deductible contributions on winding-up or revocation of endorsement
• fall within the DGR category for PuAFs.

The PuAF must also have following characteristics:

• it is a ‘fund’
• it is established and maintained under a will or an instrument of trust
• it is established and operated on a not-for-profit basis
• it is allowed, by the terms of the will or instrument of trust, to invest money in ways that an Australian law allows trustees to invest trust money
• it is established and maintained solely for the purpose of providing money, property or benefits to DGRs (except other PAFs or PuAFs) or the establishment of such DGRs.

While individuals and family groups can donate to a PuAF that supports charities that resonate with the individual or group, those with a philanthropic bent are more likely to establish a feeder fund into that PuAF, such as a charitable endowment fund. Such structures are offered by a number of organisations, such as Australian Philanthropic Services.

Charitable Endowment Funds

Individuals, family groups or corporations can establish a Charitable Endowment Fund (CEF), which is generally a sub-group of a PuAF. It is a flexible, professionally managed tax-effective structure that can be used to manage long-term charitable giving. It enables the donor/s to provide enduring gifts to charitable organisations without the administrative burden associated with the establishment and management of a Private Ancillary Fund.

The key features of a CEF include:

Reduced administrative burden: Those managing the PuAF into which the CEW feeds are responsible for the ongoing management and compliance of the fund.

Tax deductibility: Contributions/donations made to a CEF will entitle the donor to claim a tax deduction (as long as the underlying PuAF is a DGR).

Flexibility to spread deduction: for a donation of cash, publicly listed shares or other property worth more than $5,000, the donor is able to claim a tax deduction over a period up to five tax years. This enables to the donor to claim the tax deduction in a manner that best suits their individual circumstances.

Incorporating philanthropy into financial advice is crucial for fostering a holistic approach to wealth management that extends beyond individual financial goals. The integration of philanthropic considerations into financial planning allows your clients to align their financial resources with their personal values and aspirations for social impact. This approach empowers clients to make a meaningful difference in their communities and the world, leveraging their financial resources to support causes and organisations they care about deeply.

Furthermore, integrating philanthropy into financial advice encourages long-term thinking and strategic giving, maximising the effectiveness of charitable contributions and leaving a lasting legacy for future generations. Philanthropy can also be used as tax management tool, providing deductibility to reduce personal income tax, as well as concessions for the ancillary fund in receipt of the donation.

Ultimately, by incorporating philanthropy into financial advice, you can help clients achieve not only financial success but also a sense of fulfillment and purpose in their charitable endeavours, to enrich their lives and make a positive impact on society.

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References:
[1]Charities Aid Foundation, World Giving Index 2022
[2] Philanthropy Australia, Policy priorities for a more giving Australia, March 2019
[3] Charities Aid Foundation, World Giving Index 2022

The post Philanthropy and tax appeared first on AdviserVoice.

Advisers need a good understanding of self-managed superannuation funds and the tax requirements that apply to clients using SMSFs.

With assets forming nearly one third of Australia’s extensive superannuation savings pool, SMSFs continue to proliferate. This article, proudly sponsored by Allianz Retire+, explores the tax benefits of using SMSFs and the tax regimen and requirements that apply.

When the first self-managed superannuation fund (SMSF) was established in 1999, it was a result of the Wallis enquiry to allow small businesses and the self-employed to establish and manage their own superannuation accounts.

Two dozen years or so later, at end December 2023 the SMSF sector had amassed total estimated assets of $913.7 billion. These assets are held by some 614,705 SMSFs, representing 1,146,724 members^[1]. Figure one illustrates the growth in SMSF assets, from both an average and median perspective, while figure two examines the number of SMSF establishments, windups and total numbers of both funds and members.

According to the latest ATO statistical report (December 2023), SMSF members are heavily invested in equities; listed shares comprise 29 percent of total SMSF assets. Cash and term deposits are the next largest investment, comprising 15 percent, followed by non-residential property at around nine percent.

Like all superannuation funds, SMSF trustees must meet the sole purpose test: to run their fund for the sole purpose of providing retirement benefits as outlined in the Superannuation Industry (Supervision) Act 1993 (SIS Act).

The rationale for SMSFs

There are several reasons given for eschewing a corporate, retail or industry superannuation fund in favour of an SMSF. The most common reasons are:

• direct ownership of assets (rather than beneficial ownership through a superannuation fund)
• able to own direct property (residential or commercial)
• able to borrow money via a closed trust (to be used for investment purposes)
• able to own a broader range of direct assets, including artworks and collectibles
• capacity to manage tax more effectively.

The ability to maximise the benefits of SMSFs will vary for each fund and be dependent on its investment objective and those of its members. However, the reasons outlined above are not relevant for all funds or members and, in some cases, benefits may be outweighed by the costs and time requirement associated with managing an SMSF.

Those requirements include:

• the trustees need the time and skills to manage an SMSF
• trustees are responsible for operating the fund within the law; failure to do so may lead to penalties for the trustee/s and tax consequences for the fund
• trustees need to make investment decisions for the SMSF that are in the best interests of all members; at the same time, they must understand and comply with the restrictions on investments applicable to SMSFs
• trustees must comply with ATO requirements for SMSFs – failure to do so can lead to a loss of tax concessions for the fund.

Importantly, it can be expensive to establish and manage an SMSF. The fees paid for an SMSF may be more than would be paid to another type of super fund. Each year, an SMSF needs to pay for an independent audit, which must be undertaken by an independent approved SMSF auditor that’s registered with ASIC. An approved auditor will:

• Examine the fund’s financial statements
• assess the fund’s compliance with super laws
• provide trustees with a report
• report any contraventions of the SIS Act to the ATO.

Once the audit has been finalised, trustees need to complete and lodge the SAR by its due date. If the SAR is lodged more than two weeks late, the SMSF won’t be able to receive contributions or rollovers until the SAR is lodged. Once the SAR is lodged, the trustee has to pay any tax liability and the annual supervisory levy.

The supervisory levy is a fee charged by the ATO and is added to the tax return for each SMSF. When the SMSF is assessed for tax, this levy is added to the total payable to the tax office. It is currently $259.

Most SMSFs also pay for additional help, such as:

• preparing the SMSF annual return (SAR)
• valuations of the SMSF’s assets at market value so to prepare the fund’s accounts, statements and SAR; some classes of assets must be valued and reported in a specific way and trustees must have evidence of the valuation available
• actuarial certificates for SMSFs paying income streams (pensions)
• financial advice
• tax advice
• legal fees
• assistance with fund administration
• insurance for members.

Unlike personal tax, the ATO does not send out a tax assessment to SMSFs. Therefore calculating the correct tax is up to the person preparing the return. The return is a comprehensive report on all the SMSF’s transactions and benefit payments.

SMSFs and tax

Each SMSF must be registered with ATO for both an ABN and TFN. If this isn’t done, the SMSF will not be registered as an SMSF and therefore not entitled to tax concessions. Importantly, if unregistered, employers will not be able to claim deductions for contributions they make to the fund.

One of the advantages of the SMSF structure is that like a corporate, SMSFs are deemed to have income (including contributions and investment earnings) and expenses for tax purposes. At 15%, SMSFs have a low tax that can be further reduced by offsetting expenses and other tax credits.

Because SMSFs can control when assets are disposed of, capital gains can be managed in a more targeted way. For example, an SMSF acquires an asset today and it appreciates by 75% by the time its members retire. That asset can then be sold to provide income to the complying pension stream with nil tax paid on the realised capital gain of the asset.

The adaptability of SMSFs enables trustees and their advisers to optimise tax efficiency for its members. By tailoring strategies to the individual circumstances of members, and leveraging options such as contributions, reserves, and distributions, trustees can mitigate overall tax liabilities within the fund. In contrast, within pooled superannuation fund, personal circumstances cannot be factored in as members have to be treated consistently.

The SMSFs structure also provides flexibility when it comes to managing taxable liabilities. An SMSF requires only one tax return despite potentially having up to six members. If the fund includes retired members who are tax-exempt, while others remain subject to a 15% tax environment, strategic allocation of earnings from the tax paying members to the retired members can yield tax advantages.

Income tax

The income of an SMSF is generally taxed at a concessional rate of 15%. To be entitled to this rate, the SMSF has to be a ‘complying fund’ that follows the laws and rules for SMSFs. For a non- complying fund, the rate of tax applied is the highest marginal tax rate.

Contributions

Certain contributions received by a complying SMSF are included in its assessable income and are usually taxed as part of the SMSF’s income at 15% (or 47% for non-complying SMSFs). These ‘assessable contributions’ include:

• employer contributions (including contributions made under a salary sacrifice arrangement)
• personal contributions that the member has notified the trustee they intend to claim as a tax deduction
• generally any contribution made by anybody other than the member, with limited exceptions such as spouse contributions and government co-contributions^[2].

These contributions are taxed in the SMSF as income, but at the concessional rate of 15% up to the contributions cap. The cap is currently $27,500 per year and is increasing to $30,000 at 1 July 2024. The non-concessional contribution cap, currently $110,000 will increase to $120,000 from the same date.

If a member fails to provide their TFN, the SMSF will have to pay additional tax on their mandated employer contributions and cannot accept other types of contributions. The additional tax rate is 34% for complying SMSFs and an additional 2% (for a total of 49%) for non-complying SMSFs.

The difference in the treatment of contributions between super funds and SMSFs is significant. Because contributions to SMSFs are treated as income, tax is levied once the expenses of the SMSF have been deducted.

Earnings

An SMSF in the accumulation phase will have its income earned from investments taxed at 15%. Franked dividends paid by an Australian company may entitle the SMSF to a tax credit, which will reduce its overall income tax liability. As with income received from contributions, income derived from earnings will be taxed on an after expenses basis.

Non-arm’s length income (NALI)

SMSFs must always transact on an arm’s-length basis. The purchase and sale price of fund assets should always reflect the true market value of the asset and the income from assets held by an SMSF should always reflect the true market rate of return. Any non-arm’s length income (NALI) is taxed at the highest marginal rate.

The ATO judges income to be NALI for a complying SMSF if it is:

• derived from a scheme in which the parties weren’t dealing with each other at arm’s length
• more than the SMSF might have been expected to derive if the parties had been dealing witheach other at arm’s length.

For example, the ATO considers income derived by an SMSF as a beneficiary of a discretionary trust to be NALI, as are dividends paid to an SMSF by a private company (unless that dividend is consistent with arm’s-length dealing).

NALI also includes income derived by an SMSF from a scheme where the parties weren’t dealing with each at arm’s length and where the fund incurred lower expenses in deriving that income than would be expected if the parties were dealing on an arm’s-length basis.

GST

Most SMSFs don’t need to register for GST although those with an annual GST turnover of more than $75,000 must register for GST. Annual GST turnover doesn’t include contributions, interest and dividends or residential rent or income generated outside Australia. It does include gross income from the lease of equipment or commercial property.

Capital gains tax

An SMSF capital gain is any profit made from selling an asset. It’s classed as income and taxed as such. Similarly, any loss made from selling an asset is deemed a capital loss. Both need to be included in the SMSF’s annual return to the ATO.

Because capital gains are treated as regular income and an SMSF’s income is taxed at the concessional rate of 15%, capital gains are also subject to a 15% tax.

If an asset has been held for more than 12 months before it is sold, its capital gain may be eligible for a tax discount of 33%. That means, only two-thirds of the capital gain will be taxed – i.e. at the rate of 10%.

A capital loss is not an allowable deduction and can only be used to offset against capital gains. If capital losses are greater than capital gains in a financial year, they must be carried forward to be offset against future capital gains.

If the capital gain is used to fund an income stream (i.e. a member’s pension) then zero tax will be applied to the proportion of capital gain funding the pension.

SMSFs in pension phase

When SMSF income is used to provide a pension stream, there is no tax at all. However, this concession is available only to funds that comply with the ATO’s requirements for SMSFs. For those SMSFs invested in Australian equities, franking credit refunds can be claimed from the ATO for any excess credits.

Investment income received by an SMSF is tax exempt to the extent that those assets are supporting retirement phase income streams. This income is called exempt current pension income (ECPI) and is claimed in the SAR once the SMSF commences payment of one or more retirement phase income streams.

An SMSF is not automatically entitled to ECPI – there are steps that the trustee/s must take to be able to claim it.

SMSFs and property investments

One of the key benefits of an SMSF is the ability to own property. There are two primary advantages to holding property inside an SMSF.

Firstly, there’s concessional tax on rental income; rent received by an SMSF will be taxed at a maximum rate of 15%. Some expenses related to ownership of the property will generally be tax deductible to the fund, lowering the effective tax rate. These expenses include such as rates and property maintenance.

Secondly, superannuation tax rates also apply to a capital gain resulting from an increase in the property’s value. Consequently, depending on when the property is sold, any capital gain the SMSF makes on its sale could be tax-free.

For example, if a median-priced residential property of $667,000 is bought by a typical investor and sold a decade later for double the value, their capital gains tax can be $157,000. If it eventually doubles again in value, the tax bill climbs above $300,000. If that property is held by an SMSF member in retirement, the CGT is zero after age 603..

Case study: Commercial property investment

Matt and Ben are business partners in a successful plumbing business. They’d been at school together, played football together and did their apprenticeship together. As their business grew, they sought financial advice to further develop and grow their business and its profitability.

A key part of the business plan was to establish an SMSF and to purchase a commercial property. To do this, Matt and Ben each rolled their personal super into the SMSF structure. A bare trust was then established to enable the SMSF to borrow additional funds to cover the cost of the property.

The business had been paying rent to a landlord for a commercial premises; it now pays a commercial level of rent to the SMSF. At the same time, Matt and Ben continue their super contributions, split between their original industry fund (to retain insurances) and the SMSF. This ensures the loan is repaid, other expenses can be met and, over time, other assets can be purchased.

The SMSF received a rollover of $220,000 from Matt and Ben and borrowed $400,000 to purchase the commercial property for $600,000. Using a mix of income from rent, contributions and bring- forward contributions, the financial strategy sees the loan being repaid within seven years when it is estimated the asset will be worth $1 million.

In this case, the SMSF would not need to be registered for GST. Although it is receiving rental income from a commercial premises, this income does not exceed $75,000 per annum. Tax liabilities arising from income received from contributions and rent will be offset by the expenses of the SMSF and its property asset.

Conclusion

The unique flexibility of SMSFs empowers trustees and their advisers to tailor strategies that optimise tax efficiency for members. This adaptability allows for a more personalised approach, considering individual circumstances and employing tactics such as contributions, reserves and distributions to minimise overall tax liabilities within the fund. In contrast to pooled superannuation funds where uniform treatment is mandated for all members, SMSFs offer a bespoke solution tailored to each member’s needs.

The streamlined structure of SMSFs simplifies tax management by requiring only one tax return. By leveraging this structure, SMSF trustees can strategically allocate earnings, particularly benefiting retired members enjoying tax exemption. As such, SMSFs not only offer enhanced control and customisation but also deliver tangible tax advantages, cementing SMSFs as a powerful tool for wealth management and retirement planning.

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Notes:
[1] ATO, Quarterly Statistical Report, December 2023
[2] Australian Tax Office

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Advisers need to have a sound understanding of the varied tax regimens as they are applied to clients’ superannuation savings, in both the accumulation and drawdown phases.

While superannuation is arguably the most tax-effective way to save for retirement, it’s not tax free. This article, proudly sponsored by Allianz Retire+, explores tax as it applies to your clients’ super savings.

Australia’s total superannuation assets were $3.54 trillion at the end of the September quarter last year^[1], which makes our nation one of the seven largest pension markets in the world.^[2]

During the September quarter, employer contributions totalled $31.8 billion while member contributions totalled $17.7 billion over the same time period. They are big numbers that keep superannuation firmly in the sights of government agencies (including the ATO) and regulatory bodies. While such scrutiny serves important roles to ensure the security of the nation’s retirement savings, it also leads to what some call ‘tinkering’ with the system.

Although a famous quote would have us believe that death and tax are the only certainties, so too is change. And change is something that advisers are well acquainted with, particularly when it comes to superannuation – and tax. The rules pertaining to super contributions, earnings and withdrawals – including the way each of these is taxed – are subject to regular review and change.

Keeping up with the taxation system and how it applies to all investments is important, as is being able to simply explain these machinations to your clients. After all, by keeping up-to-date with the ever-changing tax and super laws, you demonstrate your commitment to your clients and provide them with comprehensive and tailored financial solutions.

How super is taxed

Super may be taxed at three points throughout its life cycle – on contributions, investment earnings and withdrawal. It’s generally taxed at a lower rate than regular income, and withdrawals are tax-free if a client is 60 years or older. However, it’s not as straightforward as that; there are different categories of contributions, the approach to taxing earnings differs from accumulation to retirement phase and withdrawals have a large number of permutations attached. The tax treatment of defined benefit pensions differ from allocated pensions.

Contributions

Limits apply to both concessional and non-concessional contributions that limit the amount your clients can contribute to superannuation each year before incurring additional tax.

Concessional contributions are those made before tax and include employer super guarantee (SG) contributions, salary sacrifice contributions and other personal contributions where your client can claim a tax deduction.

Non-concessional contributions are after tax contributions made by your client or their employer. Clients over the age of 75 may not make voluntary contributions to their super but may receive SG contributions from an employer. If a client has $1.9 million or more in the super system on 30 June in the previous financial year, they’re not able to make non-concessional contributions.

In the situation where a client exceeds their contributions cap (or limit), additional tax becomes payable. Only the amount above the relevant limit is subject to additional tax; for example, if your client contributed $10,000 over the limit, extra tax is charged only on $10,000. Concessional contributions that exceed the cap are taxed at the client’s marginal tax rate (including Medicare Levy).

For the 2023-2024 financial year, the contributions caps are:

• Concessional contributions – $27,500
• Non-concessional contributions – $110,000

Any excess concessional contributions will count towards the non-concessional contributions cap.

It’s been flagged that from 1 July 2024, there’s likely to be an increase in each of the concessional contributions (to $30,000 per annum), non-concessional contributions (to $120,000 per annum) and transfer balance cap (from $1.9 to $2 million).^[3]

Investment earnings

One of the key features that makes super such a good retirement savings vehicle is the reduced tax on investment earnings. During the accumulation phase, earnings are taxed at 15 percent and are deducted from those earnings by the fund. Once a client opens a retirement income stream, investment earnings are tax-free.

Where a client takes a lump sum and invests it outside of superannuation, investment earnings may be subject to tax.

Withdrawals

Clients must satisfy a condition of release to withdraw money from super. Conditions of release include:

1. The client turns 65, even if they haven’t retired

2. The client reaches preservation age and retires (figure two).

3. The client commences a transition to retirement income stream (TRIS) while continuing to work full or part time.

A TRIS strategy enables your client to top up the income received from their employment with a regular income stream from their super once they have reached their preservation age. This income stream enables your client to either reduce their working hours without reducing their income or continue working and increase salary sacrifice contributions to boost the value of their super.

A TRIS is a non-commutable super income stream; it must be an account-based income stream that cannot be converted into a lump sum until the member meets a condition of release with nil cashing restrictions.

There are restrictions on the amount a client can withdraw via a TRIS in any one financial year. A client under 65 years old must receive a minimum of four percent and a maximum of 10 percent of the balance of their super funds each financial year.

The exception to this is if and when your client meets a ‘nil cashing restriction’ such as they:

• • reach preservation age and retire
  • turn 65
  • become permanently incapacitated
  • are diagnosed with a terminal medical condition.

Satisfying a condition of release with a nil cashing restriction (as above) means that the pension is no longer subject to the restrictions that are generally characteristic of a TRIS.

When implementing a TRIS strategy, you and your client need to decide from which payer to claim the tax-free threshold on the client’s Tax file number declaration. If the client claims the tax-free threshold with both an employer and the super fund, they may face a tax liability at the end of the financial year.

A TRIS automatically rolls into the retirement phase as soon as your client reaches 65 years old. For the other conditions of release listed above, the client needs to notify their super fund to instigate the move from TRIS to the retirement phase.

4. The client satisfies an early access requirement, such as they:

• • Can claim on medical, compassionate, hardship or incapacity grounds
  • Can claim to withdraw voluntary contributions under the First Home Super Saver scheme
  • Are a temporary resident who is permanently leaving Australia

Tax offsets

Those clients who are retired or over 60 may be eligible for tax offsets; this is dependent on their income and assets, where their income is derived and whether they are fully or partly retired.

The relevant offsets are the:

• seniors and pensioners tax offset (only available to those who qualify for the Age Pension)
• lump sum tax offset
• super income stream tax offset.

Most super accounts are comprised of taxed and untaxed elements. A client receiving income from a super income stream may be eligible for a tax offset equal to:

• 15% of the taxed element
• 10% of the untaxed element.

The tax offset amount available to your client on the taxed element will be shown on the PAYG payment summary received from their super fund at the end of each financial year.

The tax offset amount the client can claim on the untaxed element will not be shown on this payment summary and is subject to a cap (figure three).

Tax offsets cannot be claimed for the taxed element of any super income stream your client receives before they reach their preservation age, except where the super income stream is a disability super benefit or death benefit income stream.

Lump sum withdrawals

Lump sum withdrawals may be subject to tax (figure four), especially if the client has not reached preservation age; for those under, 60 lump sum payments may be accessible only if special circumstances are met.

The low rate cap amount is the limit set on the amount of taxable components (taxed and untaxed elements) of a super lump sum that can receive a lower (or nil) tax rate. It applies to clients who have reached their preservation age but are below 60 years. It’s a lifetime cap that’s reduced by any amount previously withdrawn and applied to the low rate threshold.

Once a lump sum is withdrawn from a super account, it’s no longer considered to be super. If your client invests the money, earnings on those investments are not taxed as super and generally need to be declared in the client’s tax return.

Defined benefit pensions

Income received from a defined benefit pension is generally comprised of three components:

• a tax-free component
• a taxable component already taxed
• an untaxed taxable component.

The untaxed component is included in your client’s assessable income and tax is paid at their marginal tax, rate less a 10 percent tax offset. However, if the client is over 60, the tax-free and taxable component are generally received tax free and are not assessable.

This changes when the client’s total annual pension payments are above the defined benefit income cap, which is $118,750 for the 2023-24 financial year. In this scenario, the client will lose the 10 percent offset above this amount. In addition, 50 percent of the tax free and taxable components above this amount become taxable.

In conclusion, the importance of financial advisers understanding the intricacies of the tax regime as it applies to super system cannot be overstated. As you navigate the complexities of the financial landscape with your clients, the relationship between tax and super underscores the pivotal role that you play in optimising retirement outcomes for your clients.

In a dynamic and volatile economic environment, where legislative changes are frequent and clients may be fearful of the impact of market gyrations on their retirement savings, those advisers who possess a deep understanding of the taxation nuances within the superannuation framework are better positioned to provide relevant and up-to-date advice.

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Notes:
[1] Superannuation Statistics, ASFA, 31 September 2023
[2] Global Pension Assets Study – 2023, Thinking Ahead Institute, February 2023
[3] https://www.smsfadviser.com/news/23175-concessional-contribution-cap-looks-set-to-rise-on-1-july

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