Tax with Max: The final super transfer

Navigating the taxman in difficult times; pinning down the super/pension split; subdivision rethink.

Summary: The wind-up of a superannuation fund on the death of a member can create an opportunity for tax planning.

Key take out: When one person in a partnership dies a review needs to be made of the total value of their super fund. 

Key beneficiaries: Retirees. Category: Tax. 

Recently when answering a question relating to a one-acre block that was subdivided, I became too obsessed with an interpretation of capital gains tax (CGT) law as explained on the Australian Tax Office website. In this interpretation the ATO advises:

The profit from selling subdivided land may be a capital gain or ordinary income, depending on the circumstances. If you subdivide a block of land – such as the land on which you live – and sell the newly created block, any profit is generally treated as a capital gain subject to capital gains tax.

However, any profit is treated as ordinary income (not a capital gain) if both of the following apply:

  • your intention or purpose in entering into the transaction was to make a profit or gain
  • you entered into the transaction, and the profit was made, in the course of carrying on a business or carrying out a business operation or commercial transaction.

Upon reflection I am unsure as to how successful the ATO will be in enforcing this interpretation, their success or failure will depend on them proving that a business was being carried on. According to the ATO, “it is enough that there is a profit motive and the transaction has the character of a business operation or commercial transaction”, for the taxpayers to be regarded as carrying on a business.

As far as I know there are no legal cases that would back up the ATO’s interpretation. So unless the owners of the land undertook a major subdivision, which involved putting in roads and services, I believe that the ATO will find it hard to show that people are carrying on a business by just subdividing land.

If the ATO cannot enforce its interpretation the capital gains tax rules will apply. Under these rules when an original parcel of land is divided into two or more separate assets, the subdividing of the land does not result in a CGT event. When any of the subdivided blocks are sold the purchase date of the original land dictates whether the 50 per cent general CGT exemption applies, and the cost of the original parcel of land is divided between each of the subdivided blocks on a reasonable basis.

Planning for an SMSF transfer

Q. I run an SMSF for my wife and myself. I am unsure as to whether or not income tax is payable on assets still held in the fund when the last of us dies. Am I correct in my understanding that any assets other than cash held in the fund would attract a 15% tax plus Medicare levy on disposal whether by sale or transfer to any person who is not a dependant? Does that mean that consequently all assets should have been converted to cash whilst there is still one member receiving a pension?

Answer: There are two superannuation taxation principles that relate to a superannuation fund when the last member dies. The first principle relates to tax paid by the superannuation fund when selling assets to pay out superannuation on the death of a member, and the second relates to tax paid by non-dependants.

When the last member of a superannuation fund dies, and all of their superannuation is in pension phase, no income tax is payable on capital gains made when selling the investments to payout the benefit. When a member’s account is in accumulation phase, tax is paid on capital gains made on selling investments to payout an accumulation account benefit.

This difference in the taxation treatment of superannuation assets upon the death of a member is one of the reasons why the Coalition Government is trying to bring in the $1.6 million limit on superannuation pension accounts.

When non-dependants are paid super on the death of a member they pay tax at 17.5 per cent on the amount received. This tax treatment on the wind-up of a superannuation fund on the death of a member creates an opportunity for tax planning.

I have been advising clients that when one of them dies a review needs to be made of the total value of their super fund. An assessment of how much annual income the surviving member needs to receive is done and, then based on a generous life expectancy, the amount of capital needed to fund the pension income is calculated. If the assets of the super fund exceed the capital required to fund the pension, consideration should be given to selling the excess assets.

If the fund is totally in pension phase no income tax would be paid by the super fund when selling these investments. Once all of the excess investments have been sold a lump sum payment is made to the surviving member. These funds can then be passed on tax-free to the non-dependant beneficiaries.

This strategy does not work as well when a super fund is totally in pension phase. This is the case when the non-dependant beneficiaries are paying tax on income they earn at a higher rate than the super fund will pay.

In this case if nothing is done for an accumulation account the actual after tax distribution to the non-dependant beneficiaries, upon the death of the last surviving member, could be greater than if the investments were sold and they received the cash before the death of the member.

As this is a very complicated area of superannuation law you should seek professional advice before taking any action.

Decoding income and assets tests

Q. From January 1, 2017 would a single aged-pensioner, home owner, with income from $240,000 in superannuation and total assets of $280,000 still be entitled to the full age pension? According to the Centrelink website there is a deemed income from super of 5 per cent. This would mean $12,000 would be counted as income. I do not understand if this income is subject to the income test and reduces the age pension, if so why is it advertised this way?

Answer: There are two tests that can affect a person’s entitlement to the age pension. They are the assets test and the income test. The changes that take effect from January 1, 2017 only relate to the assets test. The amount of pension that a person receives is decided by whichever test produces the least amount of age pension.

Under the income test a person’s entitlement to the age pension is decreased when their income exceeds the low threshold of $4264. When income exceeds the lower threshold the fortnightly pension is decreased by 50 cents for each dollar earned in excess of the lower threshold.

The amount counted by Centrelink is not the 5 per cent minimum pension you receive but the income calculated under the deeming rules. With $240,000 in super this would be $7062. This means that as a single person your income will exceed the lower threshold by $2798 per annum, and result in a decrease in the age pension of $53.81 per fortnight.

Under the current assets test a single home owner receives the full age pension if their total assets are less than $209,000. With total assets of $280,000 the reduction in the full age pension for you would be $106.50.

The changes coming into effect from January 1, 2017 result in a higher threshold for single home owners of $250,000, but a higher multiple is used to calculate the reduction in the age pension. Under the new asset test rules the reduction in your age pension, with $280,000 of total assets, would be $90 per fortnight.

As the assets test produces the biggest reduction your pension will actually increase after the new assets test that applies from January 1, 2017.