If you’re looking at winding up your SMSF before 30 June, now is the time
In the life cycle of an SMSF, the time may come to wind it up. Over recent financial years, on average, around 15,000 SMSFs are wound up each financial year, representing around 2.5 per cent of all SMSFs.
Generally, when an SMSF client makes the decision to wind up their SMSF the aim is to have it wound up before 30 June so that the current financial year will be the last year that requires audit and lodgement of an SMSF annual return. It will be common that those responsible for the administration and/or compliance of SMSFs will have to attend to winding up the SMSF. In my experience it is rare for the wind-up process to occur quickly and without issues.
The key to a successful wind up is in the planning to ensure that each party: trustee, administrator/accountant, and financial adviser is aware of their role in the wind-up process and, particularly for the trustee, of the time needed to effect the wind up.
To achieve this, the wind-up process should not be left to the last few days of the financial year. Generally, it will need to start much earlier, not later than the end of April. This allows time to deal with any issues that may arise during the wind-up process.
Should the SMSF be wound up?
While there are many reasons to wind up an SMSF, it should be remembered that an SMSF can effectively be passed from one generation to the next. That is, just because one generation no longer has a need for the SMSF, it doesn’t mean that another generation could not benefit from the SMSF. Whilst an SMSF is a trust, it’s a special type of trust which is not subject to the rule against perpetuities. As such, it can go on forever (subject to any rules of the particular SMSF that may trigger a wind up).
One reason not to wind up an SMSF but continue it for the next generation is tax. Once an SMSF is wound up, any income tax losses or capital losses the fund held are lost forever. If the SMSF has either income tax or capital losses, consideration should be given to admitting new members who can benefit from these losses, rather than being lost upon winding up. For example, a fund with $50,000 of tax losses could be used to offset future assessable contributions, saving those new members $7,500 tax on assessable contributions.
Are there specific steps that must be followed?
The SMSF’s trust deed may outline specific steps to be followed as part of the wind-up process. These steps may include notifications to members, including notice periods, and how member entitlements are valued. It can also outline how to deal with an unallocated amount, commonly referred to as a “general reserve” when winding up a fund.
Assets that may be difficult to liquidate or sell
To affect the wind up of an SMSF its assets are required to be disposed of. This can be either:
- Selling to a third party for cash settlement.
- Selling to a related party for a cash settlement (with the sale price substantiated as market value).
- ‘In Specie’ transfer of the asset to a member as a lump sum benefit payment, including partial commutation of a (commutable) pension.
It is important that the disposal of assets is incorporated into the wind-up procedure to ensure that:
- Preserved benefits are not incorrectly withdrawn from the fund; or
- Benefits are withdrawn from the fund or rolled over in excess of subsequently calculated member balances.
Where fund investments are part of a reinvestment scheme, e.g., dividend reinvestment plan (DRP), consider cancelling it before selling to avoid a residual allocation after the sale. Also, if there is a residual cash balance of any DRP, request a refund at the time of cancelling the DRP.
The major stumbling block to the disposal of fund assets is any restrictions that are placed on their disposal or redemption. This commonly occurs to assets that are “frozen” investments.
There are specific guidelines relating to frozen investments in managed investment schemes, including hardship provisions which allow withdrawal of up to $100,000 per calendar year (no more than four withdrawals per calendar year) and a rolling withdrawal offer system.
However, these withdrawal rules are subject to the discretion of the responsible entity and even if permitted, may delay or not assist at all in the wind up of the fund.
An option that may be available for an SMSF with frozen assets is where the frozen asset can be paid out to the member, where the member’s benefits are unrestricted non preserved, or the member’s dependant or Estate in the case of the death of the member, as an ‘in specie’ payment. This simply involves the changing of the title of the asset and does not involve any cash outflow for the institution or managed investment scheme that holds the frozen asset.
I have had previous experience that provided you can speak to the right person at the responsible entity, such an ‘in specie’ benefit payment can be arranged, mainly due to there being no cash outflow from the managed investment scheme, it’s simply a change in ownership title of the “frozen” investment.
Where the ‘in specie’ benefit payment is arranged, it must be noted that it is still a disposal for CGT purposes and also needs to be considered for GST and stamp duty, where applicable.
In relation to ‘in specie’ benefit payments, the following should be noted:
- The regulators, both APRA and ATO, have the view that only lump sum benefit payments can be made by way of an ‘in specie’ transfer of a fund asset and pension payments cannot. Further, since 1 July 2017 a partial commutation of a (commutable) pension cannot count towards the required minimum.
- Whilst there are no restrictions as to the transfer from the SMSF to a related party, the transfer is required to occur at market value. A transfer at below market value is likely to be a breach of section 65 SIS Act and a transfer at above market value is likely to be a breach of section 109 SIS Act. Further, there are specific rules in relation to what is market value for those assets classified as collectables, including requiring market value to be determined by a ‘qualified independent valuer’.
- As previously mentioned, the ‘in specie’ transfer of an asset is a disposal for CGT purposes and must be accounted for accordingly.
- Where the fund is registered, or required to be registered, for GST and the ‘in specie’ transfer is a ‘taxable supply’ there will be GST issues to consider.
- Consideration needs to be given to whether any state duties apply to the transfer of the asset, e.g., stamp duty on the transfer of real property.
Winding up a pension fund
Where a fund consists wholly of retirement phase account-based pensions it is deemed to be a segregated fund for the purposes of claiming exempt current pension income (ECPI). Consequently, any capital gain or loss from the disposal of assets, which are treated as segregated pension assets, are ignored. To ensure that the fund remains consisting wholly of retirement phase pensions until the date of fund wind up it is best to withdraw the asset sale proceeds as either:
- Large pension payments
- Partial commutation of the pension
This will ensure that any capital gains made from the disposal of assets will be 100 per cent tax exempt with no member balances reverting back to accumulation and being required to use the actuarially determined proportionate method.
Where a member is receiving a market linked pension, this will be required to be rolled to another “complying pension”, which includes a market linked pension. The rollover fund will commence a new market linked pension; it will not be a continuation of the previous one. Consequently, new terms will be required to be chosen, e.g., life expectancy or up to age 100; reversionary or non-reversionary.
Where the members of the fund are in receipt of the old legacy defined benefit pensions, care must be taken to the effective wind up/rollover of such pensions. In these cases, it is recommended that the services of an Actuary are obtained as issues may arise, including:
- Restructure of a lifetime complying pension to a market linked pension.
- Restrictions on the commutation of a life expectancy pension that can lead to an amount left in an unallocated reserve within the SMSF.
- Loss of Centrelink benefits and in some cases claw back of previously received social security benefits (particularly for pre-1 January 2015 Centrelink grandfathered pensions).
Where an SMSF has legacy pensions or has an unallocated reserve, and the fund is to be wound up, it is recommended that an Actuary is engaged to assist with the wind up or rollover of these legacy defined benefit pensions.
GST
Where a fund is registered or required to be registered for GST, any asset disposal needs to be considered as to whether it is a taxable supply and consequently subject to GST. Funds being wound up with property, particularly commercial or vacant land, need to consider any GST application.
Where the property is being transferred to a member as an ‘in specie’ benefit payment and it is a taxable supply, GST will need to be considered in the same way as if it was a cash disposal.
The GST method utilised will also need to be determined: Margin Scheme; Going Concern; or full GST. Depending on which method is used specific criteria apply and may require certain provisions in any contract of sale. Advice should be obtained in this complex area of tax law.
SuperStream
Since 1 October 2021, to effect a rollover to or from an SMSF, the SuperStream system must be used. Consequently, where member benefits will be transferred to another complying superannuation fund as part of the wind up of the SMSF, the fund must have a rollover enabled SuperStream electronic service address (ESA).
However, certain scenarios involving a rollover to or from an SMSF will not be required to be transacted via SuperStream. The listed exceptions include an in-specie rollover of a member’s superannuation benefits to or from an SMSF.
However, it’s important to note that generally a rollover of a member’s superannuation benefits that is affected by a transfer of assets (in-specie transfer) will include a cash component. Whilst the portion of the member’s benefits that are transferred via an in-specie rollover can be implemented outside of SuperStream, the cash portion of the member’s benefits transferred would need to be transacted via SuperStream.
Corporate trustee
When winding up an SMSF with a corporate trustee the future of the corporate trustee must be decided. It’s not uncommon for an SMSF to be wound up with the corporate trustee not being dealt with. Only upon receipt of the next ASIC annual return fee is the future of the company considered.
In summary
There are many considerations when winding up an SMSF. What’s important for a successful wind up is the planning and communication – planning the wind up and who is responsible for what, communicating to everyone involved what their duties and time frames are, and educating the trustees as to the process so they understand what is involved.
