Avoiding headaches with the split of SMSF assets
Compared to APRA-regulated funds, splitting the assets of an SMSF following divorce can be a complex process involving several additional, and unexpected, considerations.
Valuing an SMSF
Whilst the Family Law Act prescribes a number of methods to value matrimonial property, SMSFs are exempt from any prescribed methods of valuation. The court therefore determines the value of an SMSF by whatever method it considers appropriate.
It is the aggregation of the value of all of the SMSF’s assets less its liabilities that comprise the value of the SMSF. However, the accounting standards and the ATO do not require SMSF assets to have a current value. It is therefore possible for the accounts to show the original value of any property, even if it was purchased many years ago.
Accordingly, before calculating any splitting payment, practitioners should ensure that:
• all assets are valued at the current date; and
• that the value reflects market value and not an ʻassessed valueʼ.
Further, many SMSFs have the capacity to create reserves. The value of the reserves needs to be taken into account when assessing the individual members’ accounts in SMSFs. Putting only the husband and the wifeʼs account balance into the property pool could disadvantage one or both the parties. Ideally, reserves should be distributed to members prior to any split.
Capital gains tax (CGT)
If one party has his or her settlement in cash then that party does not need capital gains tax deferment because all of the transferred assets will be free of CGT. However, the remaining party will bear a liability for the CGT on all of the assets that remain in the fund.
Section 126-140(2) of the Income Tax Assessment Act 1997 provides for rollover relief, where there is an in specie transfer of investment property from the trustee of one SMSF to another complying superannuation fund. The section requires the transfer to be made to another complying superannuation fund.
Capital gains tax accrued on assets in an SMSF is forgiven when those assets are used to generate a pension. For this reason, any CGT liability should be shared by dividing the assets after adding back any CGT liability. It does not matter if today there is no intention of taking a pension; the point is there is a potential to take a pension and thereby utilise the CGT that reduced matrimonial assets.
Where both the husband and the wife are seeking CGT relief, it is important both are parties to the split rather than the one who remains in the old SMSF being a passive recipient of the remaining assets.
Section 126-140(2A) of the Income Tax Assessment Act 1997 provides the preconditions to obtain rollover relief for an in specie transfer of a member’s own interest (i.e. an interest that is not subject of a splitting order), namely:
(a) assume that a married couple have an interest in the same SMSF;
(b) the wife leaves the SMSF and the trustee transfers investment property (which has an unrealised capital gain) to the trustee of another complying superannuation fund for the wife;
(c) the transfer of investment property is made in accordance with a court order or superannuation agreement; and
(d) as a result of this transfer together with a transfer following a splitting order or agreement (that is what the legislature describes as a “series of transfers”) or as a result of this transfer alone, the wife will no longer have a superannuation interest in the SMSF.
Accordingly, CGT can be avoided by ensuring the husband is also a party to the orders. If there were three or four members of the SMSF there would be no need to restructure, so CGT would not be relevant. In most cases though, the orders are structured by having one party transferring his or her entitlement to themselves.
CGT event E2 will occur where a CGT asset is transferred to an existing trust. The transfer of the husband’s own entitlement to their new SMSF is a transfer to an existing trust.
Accordingly, the transfer is not covered by subsection (2) or subsection (2A) above. Unless the transfer is made pursuant to a court order or a superannuation agreement, the preconditions for CGT rollover relief will not have been met. The CGT event will have occurred in the existing SMSF and the trustee of the SMSF (not the trustee of the wife’s new super fund) will be required to remit the necessary tax in the next return.
Complying funds and indemnities
A significant number of SMSFs are non-complying at some stage during their administration, sometimes knowingly and sometimes unknowingly. If an SMSF is found to be non-complying then an adverse audit finding may have retrospective taxation consequences on the fund.
A family law property settlement where one party provides an indemnity to the other party will address the liability issue. Caution should be exercised, however, to ensure the indemnity provided will indemnify the departing party from the date of leaving the fund.
If there is no agreement that one party is to be liable for past non-compliance then a formula should be agreed upon which apportions any liabilities between the members.
Types of splitting agreements or orders
Depending on the circumstances, the following types of splitting agreements or orders may be relevant:
(a) a percentage split accompanied by a requirement to revalue assets prior to splitting will reflect current values, and such an agreement or order would also pick up any contributions;
(b) a base splitting amount if the split involves an in specie transfer; and
(c) a base splitting amount may also be appropriate where the assets are cash only or if the assets are not volatile, or if there is an agreement to ignore fluctuations in the asset values.
Consideration should be given to splitting agreements or orders being made that are responsive to changes in asset values and client expectations. A base splitting amount could also apply a formula that will pick up fluctuations in asset values.
Geoff Brazel, solicitor, Brazel Moore Lawyers