SMSFs warned on tax traps with in-specie transfers of benefits

While this may be possible if the death benefit is being paid as a lump sum, usually this isn’t possible if it’s being paid as a pension with some exceptions.

“As a general rule, it is not possible for a member of an SMSF to transfer or sell investments held in their name. However, there are some very limited exceptions, such as investments listed on a stock exchange, commercial property, and some investments which are controlled by related parties,” Mr Colley explained.

“However, on the other side of things when a member or beneficiary become entitled to a lump sum benefit from the fund it is possible for the member to receive the benefit in cash or by the transfer of any of the fund’s investments.”

Mr Colley noted that it is also possible for a member to purchase any investment from the fund providing the transaction is made on an arm’s length commercial basis.

Usually when a super fund pays benefits to members or their beneficiaries in the case of a member’s death, Mr Colley said the amount is usually paid in cash.

“It is possible to transfer an equivalent value of the fund’s investments to satisfy all or part of a lump sum benefit, including when a pension is commuted (converted) in full or part to a lump sum,” he noted.

“However, the superannuation legislation requires that any regular pension payment is made in cash.”

While there is no limit to the type of investments that can be transferred to a member to satisfy a benefit payment, Mr Colley said it’s important to remember that transfers of investments from the fund to a member or beneficiary mean that a change of ownership has taken place.

“In most cases the ownership will be transferred from being in the name of the trustee of the fund to the name of the member or beneficiary,” he said.

“However, it is possible for the member or beneficiary to direct the investment to be transferred to someone else. Any tax liabilities that arise because of the transfer will continue to remain as a matter for the member or beneficiary.”

Mr Colley gave an example of Camilla, whose spouse has passed away. Camilla becomes entitled to a lump sum of $600,000 from her spouse’s accumulation balance in the fund.

“As the fund’s investments include some listed shares and cash, she decides to have the lump sum paid as a combination of some of the cash balance ($100,000) and by transferring some of the shares ($500,000),” he explained.

“The lump sum paid to Camilla will be a tax-free death benefit. However, as the shares have been transferred from the fund, a capital gains tax event has occurred, which means that the fund would be liable for any taxable capital gains.”

He gave another example of a member, Marcia, who has retired and is in receipt of an account-based income stream from her SMSF which has a current balance of $900,000.

“She does not have an accumulation balance in the fund. Due to overseas travel becoming available to her, she decides to withdraw $100,000 as a lump sum for an overseas trip consisting of $40,000 in cash and $60,000 in listed shares,” Mr Colley explained.

“The amount Marcia has withdrawn from the fund requires her to partially commute her account-based pension.”

As the fund is tax exempt on investments which are supporting the income stream, Mr Colley said there will be no capital gains consequences on the transfer of the listed shares to her.

“However, if she fully commuted the income stream it is treated as having come to an end for tax purposes. In this situation, any fund investments transferred to Marcia may have capital gains tax consequences as they are treated as being transferred from the accumulation phase assets of the fund,” he cautioned.

Mr Colley also stressed the importance of maintaining fund records for these kinds of transfers for avoiding tax and compliance issues.

SMSF trustees he said should keep a record of the request from the member, beneficiary or or executor of the member’s estate requesting payment of the benefit which may be a lump sum, pension or combination.

There should also be an examination of the documents confirming the entitlement of anyone claiming payment of the benefit.

“This may include proof of age, proof of identity, binding death benefit nomination, reversionary pension nomination, death certificate and similar documents,” he said.

Trustees should also have a record of a resolution by the trustees confirming the payment of the benefit, lump sum or pension, confirming the recipient and the amount involved.

There should also be records of the arrangements for the payment of cash, transfer of fund investments or a combination to the member, beneficiary or executor as required, he added.

Mr Colley explained that in situations where fund investments are transferred in satisfaction of a benefit, shares in listed companies or trusts are relatively simple as it involves contacting the registry and the trustees making an off-market transfer of shares.

“Where private companies or unit trusts are involved, it can be a simple matter of the trustees contacting the company or trust and the transfer recorded,” he stated.

“In less common situations, a benefit may be made by the transfer of real estate owned by the fund. This will require the transfer of the title of the property to the member or beneficiary, payment of any taxes, and a valuation of the property at market value,” he explained.

“The transaction needs to be on an arm’s length basis otherwise there could be tax implications for the fund under the non-arm’s length requirements.”

Mr Colley noted that some funds own boutique investments such as artworks and collectables.

“Just like shares and real estate, the transfer will require appropriate documents and valuations to justify that the transfer to the member or beneficiary was made on an arm’s length basis,” he said.

Where a member, beneficiary or member’s legal personal representative wants to have some of the fund’s investments transferred to their name in satisfaction of a lump sum payment or they want to purchase the investment from the fund, Mr Colley said the importance of establishing that the transaction was made on an arm’s length basis “cannot be underestimated”.

It is also vital to ensure that the transfer has been validly made to the recipient.