There was an important lesson for do-it-yourself superannuation fund trustees and their advisers in the Mid-Year Economic and Fiscal Outlook 2012 on the tax treatment of investments remaining in a fund on the death of a member.
In the outlook, the government announced it would legislate to ensure that investments left in a fund that is paying members a pension could (from July 1, 2012) be entitled to tax-exempt treatment while they were being sold to pay out a death benefit.
It was significant, given that it ran contrary to a long-standing opinion by the Australian Taxation Office first expressed in 2004 in an interpretive decision and reiterated last year in a draft tax ruling. This ruling (TR 2011/D3) stated that investments in a pension-paying fund lost their tax-exempt entitlement on the death of a member.
Given the opinion was expressed in a draft tax ruling, a reader writes, how legal is this? Is a draft tax ruling the law, or does it have to be a completed ruling? What if you didn’t take notice of it?
These are topical questions, says Peter Bobbin, a superannuation principal with Argyle Lawyers, which highlight the importance trustees and advisers should place on the steady stream of pronouncements made throughout the year by the ATO on superannuation and tax issues.
These come in various forms, like taxpayer alerts, draft and completed tax rulings and interpretive decisions. The significance of these various missives is that while technically some may be vague as far as the law is concerned, they can still carry a tax sting.
The lesson for trustees and advisers is they can’t afford to ignore them, says Bobbin. That’s because if a ruling follows the draft, there can be extra tax penalties for those who took no notice of any proposals. These penalties can be at least 50 per cent, but potentially 75 per cent, of the tax that wasn’t paid plus interest charges on the outstanding tax.
A tax ruling, explains lawyer Daniel Butler of DBA Lawyers, is an expression of the Tax Office’s opinion of the way in which a particular tax law applies, or would apply, to a taxpayer who has obligations or entitlements under those laws.
It’s a way for a taxpayer to find out the ATO’s view on certain laws. The idea is to reduce uncertainty for taxpayers when they self-assess tax obligations or entitlements.
A draft public ruling is not strictly a ruling according to the ATO, says Bobbin. It’s a consultative document that sets out a preliminary view about the way the law is considered to apply. That said, it does carry weight if a final ruling follows.
If taxpayers rely on a draft ruling, they are likely to be protected against the 50 per cent and up to 75 per cent penalty tax that can be imposed on those who deliberately choose not to follow the ruling. They are probably also protected against any interest charges.
Not following a ruling out of innocence, says Bobbin, is likely to attract penalties of at least 25 per cent and probably 50 per cent, plus interest charges.
One issue that still exists for DIY funds, says Butler, is how funds now deal with any tax obligations they may have where the deceased member started their pension before the July 1 start date of the new regime. This is because the draft ruling may not be finalised until after the proposed legislative change becomes law. So do funds comply with the draft ruling or rely on professional advice?
The risk of tax penalties is the reason most super advisers have since 2004 followed the Tax Office line on the treatment of investments sold to pay out a death benefit, even though many respected super advisers have not agreed with this. Some were proposing to challenge this if the draft view became the final opinion.
At a practical level, says financial planner Julian Battistella of Battistella Financial Services, DIY funds have been following the Tax Office line ever since 2004 when the ATO issued an interpretive decision (ID 2004/688). This stated that whenever there is a commutation or conversion of a pension into a lump sum – which is required if a lump-sum death benefit payment is to be paid – any capital gains liability on investments that was sheltered by a tax exemption during the pension phase resurfaced.
Interpretive decisions are ATO opinions that are publicised in response to specific questions that may be raised regularly or they arise from concerns the tax man has about super and tax rules.
Following an interpretive decision will save any penalty tax or interest if the rules change and the interpretation is amended. The only liability then will be payment of any unpaid tax or repaying any over-claimed tax credit.
Battistella describes the government decision as a huge change that means DIY funds can own investments for the medium to longer term during the pension phase, without worrying about a potential big tax hit on investments sold to pay out a death benefit.
One way some funds have dealt with this issue, he says, is to regularly sell down profitable investments while members are still taking a pension to crystallise gains in the tax-exempt phase. While this may save tax, it incurs transaction costs on an ongoing basis.