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Tax exemptions in pension mode, apportioning fees, taxable and tax-free benefits, dividend entitlements, and future income entitlements.

Summary: This article provides answers on tax exemptions in pension mode, apportioning fees from pension and accumulation accounts, taxable and tax-free benefits on the death of a sole trustee, minimum holding periods for dividend entitlements, and declaring future income entitlements in a tax return.
Key take-out: The tax exemption on the earnings of assets supporting a superannuation pension continue after the death of a member when they are in pension phase.
Key beneficiaries: SMSF trustees. Category: Portfolio management.

Tax exemptions in pension mode

My SMSF has been in pension mode for seven years. As I have other income sources I have been taking the compulsory minimum pension in one lot during June each year. I notice your comment that if I should die before the pension is paid in a year, I would be regarded as not being in pension mode. Please advise me of the significance or impact of not being in pension mode when I die?

When a superannuation fund is in accumulation phase rather than pension phase the income earned by the fund is taxed at 15% and capital gains are taxed at 10%. A fund in pension phase pays no tax on income or capital gains.

As a result of a change announced in the mid-year economic and fiscal outlook, from July 1, 2012 the tax exemption on the earnings of assets supporting a superannuation pension will continue following the death of a member when they are in pension phase. The exemption from paying tax on the income will remain in place until all of the deceased members benefits have been paid out.

Until the legislation is enacted it is unclear whether a person in the situation you have outlined will get any benefit. This is because if no pension payments have been paid to a member during the year in which they die, under the current ATO guidelines where no pension payment has been made to meet the minimum pension payment amount, the fund would not be regarded as being in pension phase.

Apportioning fees from pension and accumulation accounts

In July 2012 I started a pension account from my SMSF and I also have an accumulation account in my SMSF.  The accountant and auditor who help me to set up the SMSF pension account charge me a fee of $1,400.  Please advise me where should I pay out these expenses, from the pension SMSF account or the accumulation phase SMSF account?

It would appear that your super fund is using the segregation method, rather than the actuarial method, when calculating what portion of the fund’s income is exempt. If this is the case a reasonable way to pay these expenses is to be pay them proportionally from each bank account. This means if the pension account makes up 60% of the value of the fund, 60% should be paid from the pension bank account.

If you are not using the segregation method, and are instead obtaining an actuarial certificate that details the portion of the income relating to the pension account, it will not matter where you pay the accountant and auditor fees from.

Taxable and tax-free benefits on the death of a sole trustee

When the sole owner of an SMSF dies and the will states the funds are to be distributed, with the taxable part to the dependant spouse and the tax-free portion to the adult children, what tax is payable, by whom, when, and on what amount?

I do not believe a will can control what is paid out of an SMSF when it comes to taxable and tax-free benefits. Under normal circumstances a deceased’s benefits in a super fund, unless there is a binding death benefit nomination in place, will be paid to their estate. When the super benefits are paid to beneficiaries from the estate, and it contains both taxable and tax-free benefits, the payments will also be made up of both taxable and tax-free benefits.

The only way that I know that taxable and tax-free benefits can be treated differently is where the benefits are held in pension accounts. In this situation the pension holding the taxable benefits would be converted to a reversionary pension, with that passing to the deceased’s spouse.

The other pension account holding the tax-free benefits, upon the death of the member, should go back into accumulation phase and a binding death benefit nomination would make sure the tax-free benefits pass to the non-dependants.

Minimum holding periods for dividend entitlements

I will be 62 in August 2013. In June 2012 I withdrew all of the money that I had in bank term deposits and started buying and selling shares purely to collect the fully-franked dividends attached to those shares.

This strategy has been extremely successful since last June. To achieve this success I only keep the shares until the share price has re-bounded after going ex-dividend to what I paid for the share. Up to date this is about two to three months maximum.

This means that I have a large turnover of shares into and out of my portfolio. Can I do this under the rules and regulations of an SMSF or not? Because of my age my income would be tax free if I can do it in my pension mode SMSF and I could get a refund for the franking credits that I receive. How does the Australian Taxation Office look at dividend stripping under the wings of a SMSF?

To be entitled to imputation credits from fully franked dividends the owner of the shares must own them for at least 45 days. The only exception to this is when the total franking credit is below $5,000. This means that where the dividend received by an investor is less than $11,667 the holding period does not apply.

These rules apply equally to individuals as they do to an SMSF. The holding period rule does not affect the taxation of the dividend received by the super fund; it will only affect the fund’s entitlement to receive franking credits. This means where an SMSF receives a dividend of more than $11,667 it would need to hold those shares for at least 45 days to be entitled to the franking credit.

Declaring future income entitlements in a tax return

I am a beneficiary of an estate that was bequeathed to me by my late parents. For family political reasons the trustees and executors of the estate are not members of the family. For their own legal liability protection the trustees have decided to withhold about half the value of the estate.

Naturally this has caused some alienation from the beneficiaries of the estate. This decision was made early last year. Now the assets of the estate have accrued interest and there will be a discrepancy between the figures that I lodge for last year’s tax returns and the ones that the estate will lodge, because I will not be receiving this money.

My accountant wanted me to pay this tax as I will ultimately be the beneficiary of this money. However as I have not received the money and the trustees have indicated that they will be keeping the assets and income until after the period of legal liability has passed in 2015, I have instructed him not to lodge a return for this part of my income. In your opinion what will be the attitude of the ATO towards such a discrepancy?

I will be surprised if the trustees of the deceased estate do not include the income you are entitled to as being distributed to you on the deceased estate’s tax return. Under income tax law, where a beneficiary has a legal entitlement to income of a trust, they must declare that income in their personal income tax return. Your accountant was correct in stating that you should declare this income.

If the trustees of the estate lodge a return showing you are entitled to the income earned by the estate you could receive a please explain letter from the ATO. In this case, unless there is some information I am unaware of, you would receive an amended income tax assessment including penalties on the deceased estate distribution omitted from your tax return.

Max Newnham is a partner with TaxBiz Australia, a chartered accounting firm specialising in small businesses and SMSFs.

Note: We make every attempt to provide answers to readers’ questions, however, answers are of a general nature only. Subscribers should seek independent professional advice for more in-depth information that is specific to their situation.

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