Draft Taxation Ruling and Superannuation Death Benefits

Key points

  • Avoid tax of up to 31.5% of deceased member's super benefit by ensuring that the income stream does not inadvertently cease.

  • Ensure that the superannuation trust deed, binding death nomination or rules of superannuation income stream includes an "automatic transfer" to a dependent beneficiary in accordance with TR 2011/D3 so that the current tax free income stream continues to be paid tax free to a dependent beneficiary following your client's death.

Accountants and advisors may have been inundated with enquiries from perplexed and concerned clients in response to Australian Financial Review article entitled, “ATO ruling confirms tax liability after death” by Sally Patten published on 22 July.

The article suggests that the Australian Taxation Office (ATO) has introduced new rules to subject superannuation death benefits to taxation following the death of a member of a superannuation fund. What is this about?

On 13 July 2011, ATO issued Draft Taxation Ruling 2011/D3 (Draft Ruling) concerning the taxation consequences of the commencement and cessation of a superannuation income stream (also commonly known as ‘pension’).

The Draft Ruling clarifies the ATO’s position on the law relating to the tax treatment of superannuation income streams (issued as a draft and open for public comment until 26 August 2011) and does not introduce new rules. Specifically, the Draft Ruling considers that an income stream ceases as soon as the member receiving the income stream dies.

The ATO confirms that on the death of a member, the member is no longer entitled to the income stream and the superannuation benefits of the deceased member must be paid out of the superannuation fund. The article focuses on the adverse taxation consequences of payment of superannuation death benefits which may result in capital gains tax on the market value of the assets of up to 10 per cent and income tax of 15 per cent.

The Draft Ruling does not propose new rules. The taxation treatments of superannuation death benefits since 1 July 2007 are contained in Division 352 of the Income Tax Assessment Act (ITAA 1997) and remain unchanged. A lump sum paid to a death benefit dependent (as defined in the ITAA 1997) remains tax free. A lump sum paid to a non death benefit dependent (for example, a non dependent adult child) may be taxed up to 31.5 per cent.

An income stream paid to a death benefit dependant is also tax free if the deceased member is:

  • 60 years of age or over at the time of death or

  • under 60 years of age, and the beneficiary is 60 years or over.

It is important that the income stream does not inadvertently cease to ensure the income stream receives favourable tax free treatment and therefore complies with the Draft Ruling (see discussion below).

The superannuation laws recognise that superannuation death benefits can be paid to another person on the death of a member either as a lump sum or an income stream: Regulation 6.21(2)(a) and (b) of the Superannuation Industry (Supervision) Regulation 1994.

Importantly, in the Draft Ruling the ATO recognised that an income stream does not cease on the death of a member under any of the following circumstances:

  1. There is an automatic entitlement under the superannuation fund’s deed to the ‘dependant beneficiary’ (refer to footnote 6 of the Draft Ruling) to receive an income stream.

  2. There is a valid binding death benefit nomination in place at the time of the member’s death that entitles a ‘dependant beneficiary’ to receive a superannuation income stream.

  3. The rules of the superannuation income stream provide for a reversionary income stream to be paid to the ‘dependant beneficiary’.

The Draft Ruling emphasises the importance for advisors and members of a superannuation fund to check that the trust deed of the superannuation fund, binding death nomination or rules of the income steam expressly provide an entitlement for the dependant beneficiary to be paid an income stream (pension) on the death of the deceased member. Where one of the circumstances is not satisfied, the income stream will cease upon the death of the member and the dependant beneficiary is taken to have commenced a new income stream. If the dependant beneficiary is under 60 years of age then the income stream will be subject to income tax of 15 per cent.

As such the key point to note is that the terms of superannuation fund rules are critical. Just like with Bamfords’ case with trusts, having the right rules in place can make a significant difference to the client’s taxation position.

Authors: Chris Tsovolos & Lisa To