ATO ruling means commutation should be expedited

Mr Hallinan told SMSF Adviser that the ruling involved a trustee of an SMSF who took 28 weeks to pay a commutation lump sum, which was then ruled by the ATO to be a death benefit, not a member benefit, following the death of the member.

“Although the ruling was highly redacted there is a takeaway from this case,” he said.

“And that is, if you do a commutation before death it should be acted on quickly.”

He said from the abbreviated and redacted version of the PBR, the background to the case was that an SMSF was paying an account-based pension to a member, who lacked legal capacity and whose brother was appointed the Administrator of the member’s estate by a government tribunal.

“The brother as Administrator had the power to make decisions for the member in relation to the member’s financial matters,” he said.

“The Administrator decided to fully cash out the member’s account-based pension and completed the relevant forms to fully commute the pension and to instruct the trustee to pay the commutation amount to the bank account of the member.”

He continued that the duly completed pension commutation and payment instructions were received by the trustee and the trustee acknowledged receipt of the forms.

“It seems that after the issue of the trustee’s email to the administrator, the member died,” Mr Hallinan said.

“The SMSF had a financial adviser and the adviser was notified of the death of the member, however, as the ruling has been heavily redacted it is not clear to when but presumably shortly after the death of the member.”

The trustee of the SMSF ultimately paid out the commutation lump sum 28 weeks after the death of the member.

“The redaction of the ruling makes it difficult to appreciate the timeline but in this case it seems the commutation notice was put in before death, but it does not adequately explain why it took 28 weeks to pay it out,” he said.

“The delay of actioning saw the ATO take the decision that it [the lump sum] was paid out for other reasons and so it was treated as death benefit and taxed at a higher rate.

“This ruling means that if you do a commutation before death you should act on it quickly. We can only speculate as to whether there were other things going on such as if the fund was waiting for an asset sale or a delay in a sale to get a better price – the reason is not explained.

“But from my own knowledge, the ATO has not taken this view before and it seems like a bit of warning shot.”

Mr Hallinan said according to the documentation, the ATO accepted that the pension was an account-based pension and that the member had the right under the trust deed of the SMSF to fully commute the pension and that neither the SIS Act nor regulations prevented or restricted that right to request commutation of the pension.

“The ruling makes no mention as to whether the Trustee of the SMSF had to ‘consent to’ or ‘approve’ the commutation request,” he said.

“Presumably, then the member had a unilateral right under the trust deed to request full commutation of the pension and the only function of the trustee was to ‘implement’ that request – that is to determine the commutation value and to sell fund assets to generate sufficient cash so that payment could be made.

“Further the ATO seemingly had no issue with the Administrator exercising the power to commute the pension.

“Encouragingly, the ruling (as published) at paragraph 23 states; ‘An amount that a member requested to be paid from their superannuation fund before their death, but was paid after their death, may be classified as a member benefit instead of a death benefit depending on the facts and circumstances of the payment.’”

He said this was consistent with the relevant taxation legislation, where the key distinction between member benefits and death benefits is that the former is paid to the member as they are the fund member, and the latter where the benefit is paid to someone else because of the death of the member (section 307-5(1)).

“Less encouragingly at paragraph 25 the ruling then proceeds to undermine the clarity of the member/death benefit distinction based upon the reason for the payment with the distinction now being based upon the trustee having to consider a shopping list of relevant matters,” he said.

“The shopping list included the following critical factors:

(c) the fund trustee’s knowledge at the time of payment is made (including whether they (the trustee) are aware that the member had died;

(d) the entity that the payment is being paid to;

(f) whether the payment is made because of and is consistent with the member’s request.”

Mr Hallinan said although there is no timeframe in which to action a commutation this ruling makes it clear that it should be done as soon as possible.

“It now seems it has to be done in less than 28 weeks,” he said.

“The key point for SMSFs is that the right to commute the pension must be a unilateral right exercisable by the member so there is no requirement for the trustee to consent to the commutation or approve the commutation,” he said

Additionally, a duly authorised agent of the member can still exercise the commutation right and it is critical that the right be exercised before the death of the member.

“It is highly desirable but not critical that exercise of the commutation right be notified to the trustee before the death of the member and that the role of the trustee is simply administrative – to quantify the commutation amount and then pay the commutation amount,” he said.

“The commutation payment must be paid to the bank account of the member or paid by cheque (if cheques still exist) with the member as payee.

“And finally, there must be no extended delay between the commutation instruction being made and the payment – a rule of thumb six weeks or less.”