Draft legislation released to fix tax trap with death benefits

One of the provisions in the draft legislation will ensure that death benefits that include life insurance proceeds will not be subject to tax when they are rolled over to a new superannuation fund.

This amendment will address an unintended tax consequence that arises where a lump sum death benefit comprising an untaxed element is rolled over to another superannuation fund.

Section 307-290 of the ITAA 1997 creates an untaxed element in a lump sum death benefit in certain circumstances where the fund has claimed deductions for insurance and self-insurance in relation to the death benefit, as previously reported by SMSF Adviser.

Colonial First State executive manager Craig Day previously explained that rolling over a death benefit involves paying a death benefit superannuation lump sum to the beneficiary under the Tax Act.

“While this wouldn’t normally cause an issue, if there are any insurance proceeds included in the rollover for which the fund has ever claimed the premiums as a deduction, things can really start to get nasty,” Mr Day said.

“In this situation, there is a provision in the Tax Act that requires a fund paying a death benefit lump sum, which now includes a rollover, to calculate an amount of untaxed element to include in the payment which will then be included in the receiving fund’s assessable income and taxed at rates of up to 15 per cent.”

The draft legislation also contains a provision to correct an error in the way that market-linked pensions are valued under the transfer balance cap when they are commuted or rolled over, resulting in a nil debit.

The calculations set out in Subdivision 294-D of the ITAA 1997 for determining the transfer balance debit that arises when a capped defined benefit income stream is commuted do not currently operate as intended.

ATO assistant commissioner Tara McLachlan previously explained that due to the way these provisions are set out, if a member is commuting a pension that’s capped defined and rolling it into a new market-linked pension that’s not, they’ll end up with a credit, a nil debit and then another credit on their transfer balance account.

“This might cause issues for clients if they go into excess,” she warned.

The new subsections provide that, in the case of a full commutation of a capped defined benefit income stream, the transfer balance debit is the debit value of the superannuation interest that supported the superannuation income stream just before the commutation takes place, the explanatory materials stated.

The draft regulations also contain an amendment to maintain the capped defined benefit treatment of market-linked pensions under the transfer balance cap where they have been rolled over as a result of a successor fund transfer.

Treasury is currently consulting on the amendments up until 27 March.