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The taxation implications of a delay in death benefits

John Wasiliev

When the government announced in its 2012 Mid-Year Economic and Fiscal Outlook that it will introduce legislation to ensure the tax meter is not restarted on superannuation investments in the pension phase once a member dies, the decision was welcomed by retirees and the super fraternity.

The controversial interpretation of the law, mooted just over a year previously in an Australian Taxation Office draft tax ruling, was unpopular for various reasons.

Not only did the idea of taxing investment earnings that had been entitled to tax-exempt treatment come as a shock, it was also one many super professionals totally disagreed with.

No shortage

Noelle Kelleher, Deloitte superannuation partner, says there was no shortage of contrary opinions to the ATO’s interpretation and had the government not acted, there was a strong possibility that if the draft ruling had been finalised it would have been challenged. There was certainly a lot of lobbying against it.

Many super professionals, including Kelleher, believed the draft ruling did not reflect the majority of pension arrangements. They disagreed that a super pension automatically stopped on the death of a member, triggering an earnings tax liability on any remaining investments.

Based on the ATO’s interpretation, investment earnings that would have otherwise been tax exempt were taxable again, introducing a capital gains tax impost on investments that may have been owned for years and would have otherwise been tax free when sold to pay a death benefit.

Contrary view

The contrary view, says Kelleher, is that a pension doesn’t stop until the contractual pension arrangement between the fund trustees and the pensioner is ended. Under many arrangements, this happens when the balance of the pension account at death is paid out as a death benefit.

They argue that until that time, the fund still has a current pension obligation and is entitled to tax-exempt investment earnings, even though the member has died.

Super advisers with this view believed that if the fund paid out a death benefit as soon as practicable, (that is, when it determined the late member’s death benefit payment), sold the assets in an orderly way and made the payment, the pension then ceased.

It’s this view the government has now accepted.

Academic exercise

While the government’s decision has largely made it an academic exercise to argue against the ATO’s opinion, for at least one reader and possibly more, it has raised a question about death benefits caught in the period between the release of the draft ruling and the latest government announcement.

When the draft ruling was released, many advisers began applying it without asking how the law applied to the specific pensions they were looking at, Kelleher says.

From this a complication is that the government announcement states the tax treatment will apply from July 1 this year.

The particular reader’s situation is that his mother died in February and her DIY super assets were distributed in July.

Reader’s dilemma

The fund return was submitted recently, he writes, calculating tax payable from the date of death until the payout date – about five months. The return has not yet been processed by the ATO. Given the death benefit was not paid out until after July 1, he asks, could the return be amended so that no tax is payable during that five month period?

That the payment of the deceased’s pension account took five months to sort out, says Kelleher, does show the time it can take to organise a death benefit payment.

As far as applying for an amendment based on the latest announcement is concerned, Kelleher believes there wouldn’t be any harm in doing this.

The fund could also ask for the request to be treated as an objection if the ATO is reluctant to amend the return. While one hurdle is the legislation putting the government decision into action is not yet available, it would get things started.

The legislation will be necessary to determine the actual rules from July 1 for the post-death treatment of pension investments, such as whether they will be based on when the death benefit assets are paid out of the fund as opposed to at the member’s death.

Prior to July 2012

Another consideration is the implications if the ATO reconsiders its interpretation of the law as it stood prior to July 2012.

According to superannuation lawyer Daniel Butler of DBA Lawyers, from the information the reader provided, it is likely the government measure won’t apply because the death was in February and the change didn’t come into effect until July.

That said, this can only be conclusively determined once the details of the legislation have been released.

His advice to the reader is to keep his options open by notifying the fund’s tax agent to include a note in the fund’s tax return applying for any potential relief from the latest government announcement.

Since the announcement only commenced from July 1, says Butler, the tax agent should also monitor any application for the July 2012 period when the benefits were paid out.

Typically, there is a four-year period to object to a DIY fund tax assessment, Butler adds.

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