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Are you mistakenly thinking your clients’ super is safe?

By Peter Bobbin
August 24 2016
4 minute read
Are you mistakenly thinking your clients’ super is safe?
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With superannuation today commonly being a major financial asset of many and the mistaken perception that it is a secure investment, there is likely to be much more activity in this area in the years ahead.

The perception that superannuation is always safe from the demands of creditors is false, particularly where superannuants are making contributions with the intent to defeat creditors.

There is a general belief that superannuation is safe, that it is an investment strategy secure from the demands of creditors. This is wrong. And to prove this point, look no further than the Australian Taxation Office (ATO), which has told its own staff how to claim a person’s superannuation to pay for any tax that is owing.

The current state of security of superannuation is:

  1. The total account balance is protected if the member is bankrupt;
  2. Lump sum (not pension) withdrawals during bankruptcy is protected; and
  3. Whatever is acquired by the bankruptee with a withdrawn amount is protected.

These protections are found in the Bankruptcy Act, which is what has given rise to the myth that superannuation is a protected asset. That Act adds a few more rules;

  1. Contributions to superannuation with the intent to defeat creditors are void as against the trustee in bankruptcy;
  2. A main intent of defeating creditors can be found in a contribution that was made when the person was about to become bankrupt. Assessing whether the contribution was out of character with a pattern of making contributions will indicate a main intent of defeating creditor interests; and
  3. Any clause in a superannuation fund trust deed that seeks to disentitle a member to any interest they have in the fund in consequence of an act of insolvency by them is void as against the trustee in bankruptcy.

In summary, if a person is bankrupt their super is protected – but if super is used to avoid creditors it loses this protection.

And from there grew the myth that superannuation is a great asset-protected investment strategy. This is true if you are bankrupt, otherwise superannuation is completely exposed.

The ATO knows this, which is why it has told its debt collection staff that they can issue a garnishee notice on a taxpayer’s superannuation if they owe tax.

It may seem odd to start with a discussion about this issue by involving ATO garnishee notices, but it proves the point that super is not protected before bankruptcy. Understanding the point also helps to identify strategies to improve this situation. In Practice Statement Law Administration PS LA 2011/18 issued to ATO staff, it states:

A garnishee notice in respect of any tax-related liabilities may be served on a superannuation fund but it will not be effective until the debtor's (member's) benefits are payable under the rules of the fund (for example, the debtor retires or dies). A notice served on the fund will generally request payment as a lump sum unless the anticipated retirement income stream can guarantee repayment within a satisfactory period of time.

There is nothing particularly unique about an ATO garnishee notice and the ability for the ATO to recover tax debts against a taxpayer’s superannuation fund. The same underlying facts and issues of recovery apply with respect to any debts of a superannuant and their creditor.

Would it actually happen?

Has the ATO sought to use its garnishee power against a taxpayer-debtor’s superannuation? Yes, the writer has been engaged on several occasions where this has occurred. Want to find a ‘reported decision’? The 5 April 2013 Federal Court decision of Denlay v Federal Commissioner of Taxation considered the review of an ATO garnishee upon a person’s superannuation fund.

From a practical perspective the ATO considers the issue of a garnishee notice upon a person’s superannuation interest to be an action of last resort, reserved to where there is a real fear that the taxpayer-debtor has arranged their finances and assets so as to put these beyond the reach of the ATO. Perhaps it is this action-of-last-resort approach that explains why there is so little on the operation and potential for an ATO garnishee upon a person’s superannuation.

However, with superannuation today commonly being a major financial asset of many and the mistaken perception that it is a secure investment, there is likely to be much more activity in this area in the years ahead.

It wasn’t always this way: decades ago superannuation had its own inbuilt protection but the design of it has changed, and it is the modern design of superannuation that has added to it being exposed. A redesign of superannuation can enhance its protected status.

Modern superannuation is for the person; or in trust law language, it is a vested in interest entitlement of the member beneficiary. The result of this is that when the superannuation becomes accessible to the member (preservation no longer applies, a condition of release has occurred) it also becomes accessible to the ATO and other creditors.

What can be done?

Redesigning the superannuation interest so that it is shared with others, such as a spouse (via a reversionary pension) or a child (via an express conditional death benefit) means that the member’s interest in the superannuation is less than the whole. To this extent the redesigned superannuation should be able to resist a garnishee claim because another (the spouse or child) has a formal direct interest in the same superannuation.

If knowing that superannuation is protected is important, the nature of it needs to be redesigned from the common standard that exists today. The time for doing this is now, before a debt or garnishee arises. Any attempt to redesign superannuation because of a known and imminent garnishee will fail. But if the redesign is done early enough and for family succession reasons, a happy outcome is a lift in the ability for the superannuation to resist debtor claims. Which is probably a good thing, particularly when you consider that purpose of superannuation is for the family.

Peter Bobbin, managing principal, and Christina Wolfsbauer, senior associate, Argyle Lawyers