Australia: Latest development on the tax treatment of pension assets and death

Taxation and Superannuation Update
Last Updated: 6 February 2013
Article by Andrew O'Bryan and Rebecca James

Tax exemption continues on death

The Government has released draft legislation that applies from 1 July 2012 ensuring that investment earnings on assets supporting pensions will continue to be tax exempt until a deceased member's superannuation death benefits are paid either as a lump sum or pension to their dependants.

The impact of the legislation is:

  • assets supporting a current pension liability will not trigger a tax liability if transferred or disposed of on the member's death; and
  • the taxable and tax free components of a deceased member's superannuation interests, where amounts are held in accumulation phase and pension phase, will not need to be recalculated on death. This is important where a pension is comprised of predominately tax free amounts.

Where a member dies in the 2013 income year, the trustee is entitled to treat the pension as remaining on foot until the death benefits have been paid to the member's dependants as either a lump sum or pension.

Importantly, while the legislation is effective from 1 July 2012, Draft Taxation Ruling TR 2011/D3 is retrospective to 1 July 2007. In the intervening period, non-reversionary pensions cease on death with all the accompanying tax consequences.

We recommend trustee's hold off amending any prior year tax returns until TR 2011/D3 is finalised.

Commissioner's discretion to overlook underpayments

The Australian Taxation Office has also released an information sheet on stopping and starting a pension. The interesting part is the section on the new ATO administrative concession that applies to account based pensions commenced from 1 July 2007.

In the usual course, where a trustee fails to pay the minimum pension in an income year, the pension is deemed to cease for the entire income year, the earnings are taxed in the fund at the concessional rate and the amount received by the member is treated as a lump sum payment. In addition, the market value of the assets supporting the pension will need to be recalculated along with the taxable and tax free proportions.

However, the ATO have announced that the Commissioner will exercise his powers of general administration to deem the pension as continuing despite the minimum payment not being made if:

  • the trustee failed to pay the minimum pension amount due to:
    • an honest mistake that results in a small underpayment, being 1/12th of the pension payment required for the income year; or
    • matters outside the control of the trustee;
  • the income from the assets supporting the pension would otherwise have been exempt;
  • the trustee rectifies the underpayment by paying the amount to the member as soon as practicable (ie within 28 days of becoming aware of the underpayment);
  • the pension otherwise complies with the superannuation law; and
  • the trustee treats the catch up payment as though it was made in the prior year for tax purposes.

Importantly, a trustee can self assess and apply the Commissioner's powers of general administration the first time the trustee fails to pay the minimum pension amount, assuming the conditions set out above are satisfied. However, any subsequent underpayments will need to be referred to the Commissioner.

Where an application is made to the Commissioner, it may be difficult to establish that the above factors are satisfied given the narrow scope of the administrative relief.

What could go wrong?

This all sounds simple, so what could go wrong?

Even if all the conditions set out above are satisfied, a trustee may not be entitled to apply the powers of general administration based on the terms of the fund deed.

It is common for fund deeds to define a 'pension' in broad terms by reference to a benefit payable by instalments that satisfies the meaning of a pension in regulation 1.06 of the Superannuation Industry (Supervision) Regulations 1994 or any other provision of the superannuation law.

Therefore, where the strict requirements of the superannuation law are not complied with, the terms of the fund deed will also not be satisfied. This means the pension will not meet the definition of an income stream under the fund deed. Importantly, the Commissioner's powers of general administration cannot alter the fundamental principles of trust law to rectify the defect.

An analogy can be drawn with the Commissioner's administrative relief that permitted trust distributions from a discretionary trust to be made within two months of the end of the financial year. However, it was not uncommon for the ATO to argue at the pointy end of an audit or dispute that trust distributions were not effective from a trust law perspective as the trust deed required the distributions to be made by 30 June of the relevant financial year.

Thus, there is a real question of whether the administrative concession is sufficient where the terms of the fund deed define a 'pension' by reference to the superannuation law.

Where this is the case and the pension is deemed to have ceased at the commencement of the financial year, the deemed lump sum payments may be considered an early release of superannuation, for example if a member under age 65 and employed is receiving a transition to retirement pension.

We recommend trustees review their fund deed to ensure the ability to rely on the Commissioner's powers of general administration is not thwarted by the terms of the fund deed.

Caught between a rock and a ruling

Where a trustee has failed to make the minimum pension payments required from 1 July 2007 and the powers of general administration criteria are satisfied, the trustee is entitled to treat the pension as though it is a continuing pension.

However, where the criteria to apply the powers of general administration are not satisfied, the Commissioner takes the view that the pension ceases at the start of the relevant income year with all the accompanying tax consequences.

Again, we recommend trustee's hold off amending any prior year tax returns until TR 2011/D3 is finalised.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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