The following reader questions have been kindly answered by Graeme Colley, executive manager, SMSF technical and private wealth, SuperConcepts.
Q: It is my understanding that on death an SMSF in retirement phase has to make a tax return and pay tax on income and capital gains because it is no longer in pension mode unless it’s a reversionary pension. Is this the case and if not, what are the facts?
A: There is no requirement for an SMSF to complete a tax return as at the date of a member’s death. Also, as a general rule, the fund is not required to pay tax on the income and capital gains on the deceased member’s balance that remains in ‘pension mode’.
The superannuation rules allow you to commence two types of pensions: a reversionary and non-reversionary pension.
With a reversionary pension you will nominate a dependant who will automatically continue to receive the member’s pension on their death.
If you have not nominated a reversionary pensioner, the pension is referred to as a non-reversionary pension. The non-reversionary pension comes to an end on your death. The balance of the non-reversionary pension on your death may be subject to a binding death benefit nomination or where no nomination exists, the trustee of the SMSF may decide who is to receive the death benefit. Death benefits can be paid to your dependants, estate or a combination.
The amount remaining from the non-reversionary pension after your death remains in retirement phase until the dependants or the trustee decide how the benefit is to be paid. Any income and any capital gains earned on the fund’s investments that are in retirement phase continue to be exempt from tax. However, if dependants decide to commence a new death benefit pension the income and capital gains on the investments supporting the pension continues to be tax free. If dependants for tax purposes receive a death benefit lump sum either directly from the fund or via the deceased member’s estate, no tax is payable. However, death benefit lump sums paid to most adult children of the deceased are taxed on the taxable component of the lump sum.
Q: My wife and I are currently members of two SMSFs and wish to cease being members of one of the funds and transfer our benefits from this fund to the fund we will remain with, including a commercial property. My accountant informed me there may be capital gains to pay even if the beneficial ownership of the property has not changed. Is this correct? I am 64 and my wife 65.
A: Your accountant is correct as any fund investments that are permitted to be transferred between SMSFs are considered a capital gains event.
The ATO indicated some years ago in draft ruling TD 2004/D25 that the transfer of investments between SMSFs was a capital gains event that could result in a taxable capital gain or a capital loss. This interpretation of the law was confirmed in a Federal Court case Kafataris v Deputy Commissioner of Taxation (2008) 172 FCR 242.
Q: Say we have a husband and wife SMSF with the assets in the SMSF being $300,000 property, $3,000 shares and $10,000 cash ($313,000). Is it possible to commence an account-based pension of say $100,000 given the lack of liquidity? My understanding is that there needs to be sufficient liquidity to transfer the $100,000 to a pension account, so in this case it is not possible.
A: The amount that can be used to commence an account-based pension depends on the accumulation balance of the husband or wife. For example, let’s assume that the husband’s accumulation balance in the fund is $150,000 and the wife’s accumulation balance is $163,000. The wife commences an account-based pension with her balance of $163,000.
In an SMSF the member’s balances are not technically linked to individual investments of the fund but represent a pool of investments that are available to pay lump sum and account-based pensions to any member.
However, under the superannuation rules a fund is required to have an investment strategy that must take into account the liquidity and cash flows of the fund to pay benefits when they are due.
Therefore, providing the fund has sufficient cash flow to pay pension benefits from the pool of investments, it will meet the investment strategy requirements of the superannuation rules.
Q: Can owners of an SMSF (with individual trustees) switch to a corporate SMSF without first having to convert the SMSF assets into cash?
A: Yes, it is possible for an SMSF with individuals as trustees to be replaced by a corporate trustee without converting the fund’s assets into cash.
The reason is that an SMSF is a trust where the trustee holds the assets on behalf of the members under the fund’s trust deed. When a new trustee is appointed to the SMSF, the fund’s assets are transferred from the old trustee to the new trustee who will hold the assets on behalf of the members of the fund.
Q: Say an SMSF holds commercial property and receives rental income and also holds cash (term deposits). The fund goes into retirement phase but there is part that will be in an accumulation account for super guarantee and salary sacrifice. If the commercial property goes into the retirement phase so that the rental income is tax free, along with cash (term deposits), can the property be taken out of the assets that are in retirement phase at a later stage? I am aware that SG and salary sacrifice is taxed 15%.
A: To clarify this situation, taxable contributions include employer contributions such as SG, salary sacrifice and personal deductible contributions. These amounts are taxed in the fund at 15%. All contributions, whether they are taxable (concessional contributions) or non-taxable contributions (non-concessional contributions) are made initially to the member’s accumulation account in the fund. When a member commences a pension, they are able to use the whole of the accumulation balance or, if they wish, part of the accumulation balance.
Depending on the circumstances, where part of the fund is in accumulation phase and retirement phase an actuary will determine the portion of the fund’s income that will be taxed (the portion of the fund’s income that relates to the accumulation phase) and the amount that is tax exempt (the portion of the fund’s income that relates to the retirement phase). This is referred to as the proportional method that applies to all SMSFs where at least one member in receipt of a pension has a total superannuation balance of more than $1.7 million as at 30 June in the previous financial year. The proportional method is most commonly used by SMSFs to calculate the amount of tax payable.
However, there is another method called the segregated method that can be used where no member has a total superannuation balance of more than $1.7 million as at 30 June in the previous financial year. The segregated method allows particular investments to be allocated to the retirement and accumulation phases of the fund. Any income earned from investments allocated to retirement phase will be tax exempt and any income earned on investments allocated to accumulation phase is taxable.
It is possible for a fund that uses the segregated method to transfer the property out of retirement phase and allocate it to accumulation phase. The transfer of the value of the property must be complemented by an equivalent transfer of a member’s pension balance to the accumulation balance in the fund. As an alternative, a member may wish to convert their pension to a lump sum and have the equivalent value of the property transferred to them.
As this is a complex area, you might consider seeking professional advice.
Q: I’d like some guidance related to payment for expenses (accounting fees) for an SMSF from my personal bank account, if possible. Can it be considered as contributions? Am I breaching any laws for doing this? Will the audit report be qualified for doing this? Any comments or law links related would be much appreciated.
A: If you have a read of Taxation Ruling TR 2010/1 about superannuation contributions then it will tell you that in some circumstances where you pay expenses on behalf of the fund it will be treated as contributions. However, the expenses will not be treated as contributions if you are reimbursed for the expense incurred on behalf of the fund.
The reason for treating fund expenses that are not reimbursed as a contribution is because it is considered an effective increase in the capital of the fund. This is because the fund has received a benefit from not being required to pay the expense, such as the fund’s accounting fees.
You are not breaching the superannuation rules by paying expenses on behalf of the fund. Also, the fund’s auditor would be unlikely to qualify the fund’s accounts as there is no breach of the superannuation rules. However, most accountants and fund administrators would recommend that the fund pay expenses from its bank accounts so that it’s clear who was liable for the expense. Where a member pays expenses on behalf of the fund there is a risk that it may be missed when the fund accounts are being prepared.
Q: If a property bought by an SMSF is paid off before retirement, does the rental income still go back to the SMSF?
A: I assume that if the SMSF has purchased a property that is being paid off then the fund has commenced a limited recourse borrowing arrangement. A limited recourse borrowing arrangement is where the superannuation fund borrows to purchase an asset that is held in trust on behalf of the fund until it is paid off.
Any rental income received under a limited recourse borrowing arrangement would be included in the taxable income of the SMSF as the fund is the beneficiary of the trust. Once the loan on the property has been paid off the property may be transferred to the fund. Therefore, as the fund is now the owner of the property any rent received from the tenant will be included in the income of the SMSF.
Q: We currently have a commercial property in our property trust that is rented out to a third party. We would like to purchase/transfer this property to our SMSF. We understand that we would have to pay stamp duty on the transfer. Are we able to do this legally?
A: While there are restrictions on you or anyone related to your SMSF transferring or selling an investment to the fund, there are some limited exceptions that allow commercial property owned by your property trust to be acquired by your SMSF.
If you decide to transfer the property for no cost to your SMSF, the value transferred would be treated as a taxable contribution in the fund and would likely result in excess concessional contributions tax, which I’m sure you want to avoid.
There are two ways that your SMSF can purchase the property from your property trust. The first is for the fund to purchase the property for cash and the second is to use a limited recourse borrowing arrangement (LBRA). An LRBA involves your SMSF borrowing from a financial institution or a related party to purchase a single property that is held on trust for your SMSF until the loan has been paid off. If you decide to use an LRBA it is worthwhile to obtain professional advice as it can involve a number of complex transactions.
Whether stamp duty is payable depends on the state in which the property is located. In some states there may be no duty payable. You would need to check this with someone who is experienced in that area, such as a tax expert, lawyer or conveyancer.
Don’t forget that there may be other costs and taxes payable on the purchase of the property by the SMSF. This would include fees for the transfer of the property title to the fund and the family trust may have a capital gains tax event.
Q: If an SMSF owns a residential property outright, can the property be used as equity to borrow against as security to fund another purchase of a property in the SMSF?
A: The simple answer to your question is no – your SMSF can’t borrow to purchase a property that will be directly owned by the fund. Also, it is not permissible for a fund to use a property it owns as security for a borrowing.
However, there is an exception that allows your SMSF to enter into a limited recourse borrowing arrangement. This allows the superannuation fund to borrow in very limited circumstances to purchasing a single asset that is held on trust for the SMSF until the loan is paid off. There are a number of steps that need to be undertaken that can be complex. I suggest you obtain professional advice from someone experienced in SMSFs and limited recourse borrowing arrangements.
Q: I have a question about ending an SMSF and rolling over to an industry fund or the like. I understand that to end the SMSF, there are a number of steps that need to be followed. Do we need to cash in all assets (shares, managed funds)? When would CGT be payable on assets like shares and managed funds that have made a profit over time? I am 57 (just retired) and my husband is 66.
A: When winding up an SMSF the first place you should go is the trust deed, which may have rules on what is required. Usually the trust deed will require the trustees to resolve to wind up the fund. Once this has been done all income, contributions and expenses of the fund should be accounted for and the member’s balances calculated.
To rollover a member’s benefit to the industry fund from 1 October 2021 the SMSF is required to be registered for SuperStream so that benefits can be transferred electronically. Your fund will need:
- An electronic service address (ESA) – you can get an ESA from an SMSF messaging provider
- An Australian business number (ABN)
- Up-to-date details of your SMSF with the ATO, including your SMSF’s unique bank account.
Cashing the fund’s assets will depend on whether the industry fund will accept the transfer of the assets or will only accept the transfer of the benefit in cash. I suggest that you contact the industry fund to see whether they will accept the transfer of assets and what they require.
Where assets are in accumulation phase and the benefit is transferred to the industry fund, a capital gains event has usually occurred. If that’s the case there may be a capital gain or loss arising from the sale or transfer of the asset. This may result in a net taxable capital gain that is taxed in the fund at 15% or, for assets that have been owned by the fund for more than 12 months, a one-third discount applies so that, in effect, the taxable capital gain is taxed at 10% in the fund.
Here is a checklist to assist you with the winding up of the SMSF:
- Look at the fund’s trust deed to find what it says about winding up the fund
- Gain trustee resolution to wind up the fund
- Collect any outstanding contributions
- Pay any outstanding bills
- Calculate member’s benefits in the fund based on the market value of its investments
- Ensure that the fund is registered for SuperStream to allow benefits to be transferred to the industry fund
- Rollover benefits to the industry fund
- Notify the ATO of the wind up of the SMSF
- Gain trustee resolution that the fund has been wound up
- If the fund has a corporate trustee consider winding it up.
After the fund has been wound up you will need to retain some of the fund’s records for up to 10 years.
Records that you are required to keep for five years are:
- Accounting records that provide accurate information about the transactions and financial position of the fund
- Annual operating statements and annual statements of the fund’s financial position
- Copies of all SMSF annual returns lodged with the ATO
- Copies of any other statements lodged with the ATO or provided to other super funds.
Records that you are required to keep for 10 years are:
- Trustee minutes of meetings and decisions on matters affecting the fund
- Records of changes to trustees and a member’s written consent to be appointed as a trustee
- Trustee declarations recognising the obligations and responsibilities for any trustee, or director of a corporate trustee, appointed after 30 June 2007
- Copies of all reports given to members
- Documented decisions about storage of collectables and personal use assets.