Deceased estates and long-awaited tax certainty
With the Income Tax Assessment Amendment (Superannuation Measures No 1) Regulation 2013 being passed on 3 June 2013, deceased estates have the tax assurance they have been waiting for.
What was the issue?
Most practitioners would be aware that investment earnings earned by superannuation funds in respect of assets supporting complying pensions are exempt from income tax. However, there has been a degree of uncertainty as to what happens with this exemption upon the death of the pensioner.
The level of uncertainty significantly increased following the issuing by the ATO in 2011 of Draft Ruling TR 2011/D3 which led to great angst within the superannuation industry.
The ruling specified that a pension would cease at the member’s death, unless it was automatically reversionary. Where a pension was not reversionary, it would revert back to accumulation phase.
Practically, this meant that capital gains realised on assets sold after death were subject to tax, eroding the value of death benefit available for beneficiaries. This was of particular concern where assets were sold in the financial year after death. Potentially all capital gains were taxable.
What has happened?
Effective from 1 July 2012, the meaning of “superannuation income stream benefit” was expanded for the purposes of the earnings tax exemption. This regulation amends the law such that following the death of a person who has been receiving a complying pension, the pension earnings exemption will continue until the deceased member’s benefits have been paid out of the fund. The benefits can be paid as either a lump sum or commenced as a new pension to an eligible beneficiary.
What does it mean for beneficiaries?
From a practical perspective, the continuation of the tax exemption will allow for the disposal of pension assets on a tax-free basis to fund. This will assist to maximise the quantum of death benefit payments to the beneficiaries.
Are there any catches?
There are points to be aware of when considering how the regulations may apply in specific circumstances.
The regulations only apply to account based pensions; market linked pensions and allocated pensions, all of which must be complying pursuant to the relevant sections of the SIS Act. As a consequence, the regulations do not apply to defined benefit superannuation funds.
With the exception of investment earnings on assets already held by the fund at the date of death, the tax exemption does not apply to amounts that are added to the superannuation interest after death. Examples of such amounts are proceeds of life insurance policies; anti-detriment payments, or proceeds from self-insurance.
The regulation stipulates that the death benefit is to be paid out of the fund… “as soon as practicable after death”, with no definitive indication of what that actually means.
Finally, the way this continued tax exemption on pension assets after death would operate within the parameters of the proposed $100,000 cap on the pension income exemption, as announced by the government in April 2013, is not clear. However, depending on the specific circumstances, it may diminish the effectiveness of these new regulations.
Below are examples which illustrate the effect of the regulations in practice.
Example one
Mary was receiving a complying account-based pension from her superannuation fund. She was the sole fund member and died on 24 October 2012. The income stream was not an automatically reversionary income stream.
Mary’s husband decided to take the death benefit in a single lump sum of $600,000. The death benefit was paid after Mary’s death, on 10 April 2013.
The death benefit did not contain any insurance or other amounts, and consisted solely of the balance of Mary’s superannuation interest at the date of her death, plus investment earnings.
For the purpose of the earnings tax exemption Mary’s superannuation interest will continue as tax exempt from 24 October to 10 April. Her fund would remain 100 per cent exempt from income tax.
Example two
Consider the same facts as Example one but included in the $600,000 death benefit was $100,000 from a life insurance policy received on 15 January 2013.
For the purposes of the earning tax exemption, $500,000 will be taken to be the amount exempt from income tax from 24 October to 10 April. The $100,000 will be classified as an amount, other than investment earnings, added to the superannuation interest after death, and therefore is not income tax exempt.
Summary
Income Tax Assessment Amendment (Superannuation Measures No 1) Regulation 2013 has delivered on the government’s intention to provide deceased estates with greater certainty in relation to the taxation of income generated by assets supporting superannuation income streams. The continued effectiveness of this measure may be contingent on other legislative changes that may occur around it.
Tracy Williams is the chief executive officer at Bendzulla.
