Who has control of your super fund balance when you die? Wooster v Morris

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It's likely you already know that super lies outside your will.  You probably have thought about and may have executed a Death Benefit Nomination and think that you've covered this issue.  You may need to think again.  A recent Supreme Court of Victoria decision highlights some important issues for those wishing to ensure their super account balances are passed to the right beneficiary or beneficiaries in a timely manner.

In November 2013, in the case of Wooster v Morris, Justice McMillan upheld the validity of a binding death benefit nomination which had been determined by the self managed super fund's trustee to be invalid.  What was the problem?

Let's set the scene.  Maxwell Morris had two daughters, Susan and Kerry, with his first wife.  In March 2008 Maxwell Morris made a binding death benefit nomination in favour of Susan and Kerry, prior to his death in February 2010.  At the time of his death, Maxwell Morris and his second wife, Patricia, were both members and individual trustees of the super fund.  After Maxwell died, Patricia appointed her son (from a previous marriage) Nathan Ashman as co-trustee and then together they sought advice from DLA Piper solicitors about the validity of the binding death benefit nomination.  Patricia and Nathan subsequently resolved to replace the trustees with a corporate trustee, Upper Swan Nominees Pty Ltd.  Patricia was the sole director and shareholder of Upper Swan.  There were also accounting errors made by Patricia's accountant for the years 2009 and 2010 because the accountant had not accurately recorded Maxwell's entitlements under the accounts in his name for those years.

DLA Piper solicitors gave Patricia,  Nathan and Upper Swan legal advice that the  binding death benefit nomination was invalid and not binding on Upper Swan as trustee. This advice was based on their instructions that the binding death benefit nomination had been prepared by Maxwell but not delivered to Patricia, as required by the terms of the super fund trust deed.  Upper Swan then resolved to accept the legal advice and determined that the Binding Death Benefit Nomination was not binding on it as trustee.  All the funds in Maxwell's super fund accounts were then applied to Patricia's super fund accounts held solely in her name.

Susan and Kerry issued proceedings in the Supreme Court seeking to enforce the Binding Death Benefit nomination.  There was over $900,000 from Maxwell Morris' accounts in the super fund at stake.  The Court upheld their claims in full and ordered costs and interest against Patricia and Upper Swan.  However, Susan and Kerry had to wait over three years and incur the stress and financial strain of bringing a court action to recover what was rightfully theirs.

What could Maxwell Morris have done differently?  

The best thing he could have done was establish the super fund with a corporate trustee - perpetual succession of the corporate entity deals with the issue of survivorship of individual trustees, or loss of legal capacity which is often an issue with ageing trustees. Maxwell Morris could have bequeathed his shareholding in the trustee company to his chosen beneficiary, thus preserving his control over the entity.  In this case, Patricia Morris alone held the purse strings after Maxwell's death and there wasn't anything that Susan and Kerry could do about it after Maxwell had died, even though they were fully entitled to all his benefits in the fund.  

If your fund doesn't have a corporate trustee, you can still adequately deal with the issue of trustee succession by specific provision in the trust deed for appointment of a replacement trustee on death or incapacity.  It's relevant to know the procedures such as obtaining consent of the replacement trustee ahead of time and whether the decision of the remaining trustee or trustees is determined by the majority account balance holder or another provision in order to avoid deadlock or unsatisfactory decision making.  Needless to say, you still need to have a current Will nominating the right legal personal representative for you, and you should always have a current Enduring Power of Attorney in place to deal with your personal assets.  

Sage Advisers generally recommends the preferable structure for SMSFs is to have a corporate trustee and encourages clients regularly to review the death benefit nominations of all SMSF fund members.  We work together with clients' solicitors to structure things correctly at the outset, and review them along the way.

Tax breaks in the "Age of Personal Responsibility"

Treasurer Hockey has called an end to the "Age of Entitlement", see here. Describing the SPC decision as a signal to the rest of the country that past practice no longer applied, Hockey said it was up to businesses to take all necessary steps to get their own houses in order before the last resort of seeking a government bail-out.

''The age of entitlement is over. The age of personal responsibility has begun.''

'I say to you, emphatically, everyone in Australia must do the heavy lifting now'.

No-one's quite sure how this will all pan out. SPC is the current target politically, however there are big dollars up for grabs if policy changes are made to the tax treatment of superannuation and other concessions such as the 50% discount on capital gains tax and the CGT exemption of the family home.

Chris Richardson, economist with Deloitte Access Economics has estimated together these tax breaks amount to $66 billion in the coming year. The Abbott government has indicated that there will be a review of taxation in a white paper later in 2014.

Richardson states he considers the superannuation concessions to be necessary but not equitable and need to be revisited, in accordance with the recommendations of the 2012 Henry Review.  We have previously covered the range of changes proposed during 2013 to superannuation earlier in this blog. The main argument made by proponents for change in this area is one of equity. The poor pay more in a flat tax treatment and the rich benefit more.  The contrary argument is that when the rich make more money, this benefits everyone by their paying more tax overall; effectively growing the pie as well as encouraging people to save.

The combination of the capital gains discount, the ability to negatively gear rental properties, state stamp duties and land taxes also came under scrutiny in the Henry review. The then Rudd government ruled out any tinkering with negative gearing or the 50 per cent capital gains tax discount. But the review had recommended a broad-based land tax to replace “inefficient” property taxes.

Both the Institute of Chartered Accountants in Australia (ICAA) and CPA have made recommendations recently in these areas, such as restricting lump sum withdrawals from superannuation and encouraging income streams as a viable alternative.  Both associations have indicated the desirability of a systemic approach rather than piecemeal reform.

We consider the government should:

• apply GST to all spending except wages;
• broaden the land tax base;
• abolish stamp duty and payroll tax;
• increase the progressive personal income tax thresholds;
• raise pensions and income support for those who need them; and
• leave superannuation alone.  It has been modified and tinkered with too many times and another change would further erode confidence in the system.

These policies are unlikely to be implemented across the board. However, they would achieve, and reach sooner, the outcome of a balanced budget instead of passing on ever increasing deficits to the next generation.  And this would be the real "Age of Personal Responsibility".

How low can your interest rate go? SMSF related party loans

SMSFs are allowed to borrow from a related party

The ATO states that the law does not prohibit the lender from being a related party. However, SMSFs must continue to comply with other legislative requirements. For example, the SMSF must satisfy the sole purpose test and comply with existing investment restrictions such as those applying to in-house assets and prohibitions on acquiring certain assets from a related party of the fund.

To know whether it is acceptable for related parties to lend to an SMSF on favourable terms, including 0% interest rates it is necessary to consider the full implications of the non-arm’s length income provisions in section 295-550 of the Income Tax Assessment Act 1997 (Cth).

Non-arm’s length income provisions

Broadly, income is non-arm's length income of a complying SMSF if:

• it is derived from a scheme or investment in which the parties were not dealing with each other at arm's length, and
• that amount is more than the amount that the SMSF might have been expected to derive if those parties had been dealing with each other at arm's length.

"Non-arm’s length income" is taxed at 45%.

ATO's position

The following comes from minutes of the June 2012 National Tax Liaison Group as tabled at the December meeting:

·        The ATO position on low rate loan arrangements and LRBA is that that they do not generally invoke a contravention of the SISA, do not give rise to non-arm’s length income under section 295-550 of the Income Tax Assessment Act 1997 (ITAA), do not invoke Part IVA of the ITAA 1936 and are not considered to give rise to contributions to the SMSF just from that one fact alone.

·        Taxpayer Alert 2012/7 was released on 20 November 2012 to warn SMSF trustees and advisors to exercise care to ensure any arrangements entered into by an SMSF to invest in property are the right investment for their SMSF and are properly implemented, particularly those involving LRBA or the use of a related unit trust. See also our earlier post: Beware! SMSF investing in Property

·        Issues and concerns of low rate loans and LRBA will be submitted to the review of borrowing. The ATO will be providing comments for the review when it commences.  This is likely to form part of the new Commonwealth Government's tax review although details are not yet to hand.

The ATO recently considered this in two private binding rulings (see 1012414213139 and 1012396819768). These rulings involved SMSFs that had 0% interest rate loans from related parties. In both the ATO concluded that the income derived was not non-arm’s length income which is positive news for those taxpayers. However, private rulings are not binding on the ATO and the full details are not always made public.

Take care and get a Ruling

Although limited recourse borrowing arrangements (LRBA) are becoming more common, care must be taken, especially with related party loans. Particular care should be taken in respect of non-arm’s length income given the tax consequences.

If an SMSF wants to engage in a related party borrowing transaction with favorable terms for the SMSF (ie, non-arm’s length terms) you must apply for a private ruling from the ATO and it is likely that such a ruling would only be applicable for 12 months.

It would not surprise us if in time s. 109 of the SIS Act (investment at arm's length) is amended to include related party loan transactions at market value.

Hockey & Sinodinos clear the tax backlog

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The Commonwealth government announced on 6 November 2013 that it would "scrap" a series of tax proposals introduced under the previous Labor government, including planned changes to the fringe benefits tax and moves to raise taxes on earnings from superannuation pension funds which it described as "unworkable".  Treasurer Hockey and Assistant Treasurer Sinodinos said this was the result of an audit of 96 unlegislated and unresolved tax and superannuation reforms dating back to 2001. Four of those proposals were dealt with by the coalition's plan to repeal the carbon and mining taxes, leaving a total of 92 proposals.

Key points:

• government will keep 18 of 92 unlegislated tax proposals
• remainder to be either dumped, amended or reviewed, a cost of $3.1b to the budget
• cap on self-education expenses dumped
• low-income superannuation tax offset linked to mining tax scrapped
• fringe benefits changes for car industry dumped
• government keeping Labor's tobacco excise increase, raising $5.3b for budget

SMSF trustees have welcomed the government’s decision to scrap the cap on tax-free income streams in retirement.

The Association of Superannuation Funds of Australia said dropping the mooted 15 per cent tax on annual superannuation earnings above $100,000 removed uncertainly around the retirement savings system. Critics noted that the decision to scrap this tax along with the Low Income-earners Super Contribution (LISC) unfairly targets Australia's lowest earners see for example the views of Industry Superannuation Association here.

Generally, commentators suggest that a wider review of tax is needed and that it must be tied to a national productivity agenda - see for example the comments from Stephen Martin of CEDA: VIDEO: CEDA's Professor Stephen Martin speaks with ABC News Breakfast (ABC News) 

The Institute of Chartered Accountants Australia today welcomed the government’s decision not to proceed with the $2,000 cap on the tax deductibility of self-education expenses.  Chief Executive Officer Lee White said today’s announcement was a win for common sense.  “The government must be congratulated for having the foresight to see that this was bad policy.  Education is the key to our economic prosperity and this cap would have hurt our productivity down the track,” he said.

The Institute said the government’s announcement related to companies looking to establish offshore subsidiaries is welcomed.  “The decision not to proceed with the repeal of interest deductions for companies borrowing to expand offshore will help make Australia an attractive place for international business,” Mr White said.

The government has indicated its intention to resolve all policies relating to the tax backlog by 1 December 2013 for inclusion in the Mid-Year Economic and Fiscal Outlook, with a view to legislation passing by 1 July 2014.  

Treasurer Hockey also announced that a tax White Paper would be commissioned such that proposed changes would be taken to an election.

Hybrids - wolves in sheeps' clothing?

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In ancient times, the mythological hybrid was a creature combining the body parts of two or more species. Now the financial product bearing this name is also a beast of varied parts. Some important hybrid instruments are preference shares, convertible/exchangeable debentures/bonds and debt with attached warrants.

From an issuer perspective, hybrid securities may allow the issuer to raise capital while achieving a particular accounting, tax, credit rating or regulatory capital outcome. Following reduced activity during and immediately after the GFC, hybrid securities have recently been used for significant capital raising by both banks and well-known corporate entities.

Did you know there has been more than $18 billion of hybrids issued by banks and companies in Australia since November 2011?  There were approximately 75,000 investors in hybrid securities last year, two thirds of whom were self-managed superannuation funds (SMSFs).  

Hybrid securities often promise ‘high yields’ and are issued by well-known companies with trusted brands, but investors need to very carefully consider the features and risks before investing. Some hybrid securities make investors take on 'equity-like' risks but only give them at best, 'bond-like' returns. Some also have terms and conditions that allow the issuer to exit the deal or suspend interest payments when they choose. Some are very long-term investments (for example, more than 20 years).

ASIC is concerned about the marketing and promotion of these products. It released a report on 20 August 2013 dealing with this issue.  Why?

The issues are:

• inappropriate labelling of hybrids and unwarranted comparison of hybrids to different, less risky products eg covered bonds or senior debt
• advisers spruiking potential higher returns and using the brand name or reputation of the issuer without identifying the higher risks attached to that specific product
• investor education - do you know what a hybrid is and how it works?  Can you assess its risk profile?

Terms and conditions of each hybrid issue vary and in some cases they include features that mean they rank closer to equity than debt. Many involve heightened risks for retail investors, such as risks deriving from long maturities and more complex features such as interest deferral or potential conversion into ordinary shares. 

The overall complexity of hybrid securities makes clear, concise and effective disclosure to investors in a prospectus more difficult. 

All investors including SMSF trustees have a duty to understand their investments and ASIC has said it expects issuers, brokers and advisers to take particular care to promote clear communication to investors about the nature of an investment in these securities.  

You can download the ASIC report here: REP 365 or read more about hybrids on ASIC's moneysmart website here.  Call Sage Advisers if you have any questions about hybrids.

Superannuation - campaign convergence

abc.net.au

We have been keeping you abreast of political announcements on the superannuation front since February this year: see Super Update and Super Election.

With 10 days to go before the Federal Election to be held on 7 September, it's timely to revisit the major parties' policies.

1. The 5 April 2013 statement by then treasurer Swan and superannuation minister Shorten put an end to much speculation that the tax breaks on super would be cut. Superannuation as a short term revenue fix was largely off the agenda.
2. Treasurer Chris Bowen announced on 6 August 2013 that the ALP government would not make any "major changes to superannuation tax policy" for five years.
3. The Coalition Liberal/National Opposition has met this with a pledge not to implement any "detrimental changes" to superannuation.

This means:-

1. The increase in Superannuation Guarantee to 12% will continue (the first increase began 1 July 2013) under the ALP but would be frozen at 9.25% for two years by the Coalition if elected, then the increase to 12% would be delayed by two years.
2. The Liberals have said they will wind back the Low Income Super Contribution (LISC) which refunded the 15% contributions tax for Australians who earn less than $37,000 a year. At the time this was introduced in 2012 by the ALP government, it was to be funded by the mining tax revenues, which, as we now know, have not eventuated.
3. The higher concessional caps will remain in place under the ALP and are likely to remain under the Coalition (as yet silent on the issue).
4. If the ALP is re-elected, legislation to establish its proposed Super Council will be brought forward so any future changes to legislation are consistent with an agreed Charter of Superannuation Adequacy and Sustainability. We don't know the attitude of the Coalition to the enabling legislation for the Super Council.

The Coalition intends to conduct a tax review in its first term but details are not yet available.

Super Update

www.smh.com.au

Friday 5 April 2013 brought the much-vaunted announcement by Financial Services and Superannuation Minister Shorten and Treasurer Swan in relation to superannuation.  We have discussed the issues at length here at Super Election and SMSFs - Less Change the Better.

Liz Westover, at the Institute of Chartered Accountants in Australia observed:

...there were no real wholesale changes announced. In fact, the government was quite deliberate about where the reforms were targeted. The announcements today are not guaranteed to pass through to legislation prior to the September election, so we may still have a period of uncertainty. However, at least now we know the government’s policies on super leading up to the election.

Council of Superannuation Custodians

• Establishment of a council of superannuation which will be responsible for ensuring future policy changes regarding superannuation are in line with a new superannuation charter outlining the core values and principles for superannuation policy in Australia.
• This council will aim to ensure that superannuation policy is not driven by the annual political budget cycle but instead focuses on the longevity of superannuation to ensure certainty in the superannuation system for all generations of Australians.

The express desire to remove the politics from policy in this area is admirable and bipartisan support together with broad participation from the superannuation industry should ensure this council's success.  The media release on this aspect is here.

15% Tax on Earnings over $100,000

This is the aspect which has attracted most attention by commentators. It comprises:

• a restriction on the tax concessions available in pension phase.  From 1 July 2014, future earnings (such as dividends and interest) on assets supporting pensions will be tax free up to $100,000 a year for each individual. Earnings above $100,000 will be taxed at the same concessional rate of 15% that applies to earnings in the accumulation phase.
• the $100,000 threshold will be indexed annually with CPI and will increase in $10,000 increments.
• the Government announcement states that this reform is expected to affect only around 16,000 Australians who have balances around or above $2,000,000 (assuming a 5% return).

Special provisions will apply to capital gains incurred on assets purchased prior to 1 July 2014.:

• For assets purchased prior to 5 April 2013, the reform will only apply to capital gains that accrue after 1 July 2014;
• For assets purchased between 5 April 2013 and 30 June 2014, individuals will have the choice of applying the reform to the entire capital gain, or only that part that accrues after 1 July 2014; and
• For assets purchased from 1 July 2014, the reform will apply to the entire capital gain.

Individuals therefore have some time to determine how they will restructure their superannuation assets to account for the new reforms.

The reforms will not affect the taxation of superannuation withdrawals, these continue to be tax free after attaining the age of 60.

The new reform will apply to defined benefit funds (e g government employees' pension schemes).  This will be achieved by calculating the notional earnings each year for defined benefit members who receive a concessionally-taxed pension. The calculation will be based on an actuarial calculation. Where a person’s notional yearly earnings as calculated by an actuary exceed the $100,000 threshold, the amount in excess of $100,000 will be subject to tax at a rate of 15 per cent.

The media release regarding these reforms can be found here.

Other Superannuation Reforms

The government also announced a number of other superannuation reforms including:

• Simplification of the design and administration of the higher concessional contributions cap;
• Changes to the treatment of concessional contributions in excess of the annual cap;
• Extension of the normal deeming rules to superannuation account-based income streams;
• Extend concessional tax treatment to deferred lifetime annuities; and
• Further reform to the arrangements for lost superannuation.

Of particular relevance to SMSFs, some points mentioned by Minister Bill Shorten at the media conference include:

• the government announced an increase to the concessional contributions cap for those aged over 60 at 1 July 2013 to $35,000 with this increase extended to those persons aged over 50 at 1 July 2014.
• excess concessional contributions will be able to be withdrawn from the fund by the member and will be taxed at the individual’s marginal tax rate (plus an interest charge) not the top marginal tax rate.

The media release regarding all these changes can be found here.

What do people think about the proposals?

1.Political compromise - it won't balance the budget and it may not see the light of day

The total amount to be gained by the government is estimated to save around $900 million over the forward estimates period.  This is not going to be the "magic bullet" to balance the May budget. Bloomberg reports the total shortfall is A$26.8 billion for the first seven months of the financial year, according to Treasury figures released March 15, 2013.  

Overall, most industry participants seem to say that the reforms are reasonable but they are still "tinkering" with the system.

Some have questioned whether feared industry and media backlash led the government to back down on some of the reforms: see John Brogden on 7.30, interviewed by Leigh Sales on 3 April (video link).  Similarly, in the wake of the March failed ALP leadership spill the senior resignations of Ministers such as Simon Crean, Martin Ferguson and Kim Carr called for the end to the "Class War" rhetoric and policy and the implication is that government proposals regarding superannuation formed part of that "war".  Some others still see the current proposals as "the latest in a long line of failures to properly consult, co-operate with stakeholders, persuade the public and maintain a decent political position" see here. Others have noted the proposals' implementation date (from July 2014) and wonder whether they will be implemented given the election to take place between now and then.

2. Long term impact on government liability for aged pensions

In terms of the possible implications of the legislative changes, Mercer released a report on 8 April 2013 which concludes that increasing the taxation of superannuation would reduce future superannuation benefits and thereby increase future age pension payments. This adds another voice to the opposition to "continuous tinkering" which has been heard by many involved in the superannuation debate. Mercer argues this will "drive Australians to seek alternative tax-effective vehicles for voluntary super contributions".

3. Impact on long-term growth assets inside super

Anna Carrabs, Chair of the Institute of Chartered Accountants Superannuation Committee and Director, Associations of SMSF Members Australia noted on Lateline (video link) on 5 April 2013 that the proposed changes may have unintended consequences by encouraging people not to have long term investment goals (such as buying property inside superannuation) and instead going for "short sharp bursts to keep them inside the $100,000".  In this interview she explains how the purchase of property with a significant long term capital gain may trigger tax consequences on realisation of that asset down the track.  Carrabs also notes that the primary residence exemption from CGT and land tax means wealthy Australians can still access aged pensions if their affairs are structured well.  Her point is that taxes on superannuation earnings need to be considered together with other taxes, both Commonwealth and State, in order to have a fair and equitable system which provides the best tax base.

4.  Impact on eligibility or extent of aged pensions

Aged pension recipients may be negatively affected by changes to the deeming provisions in these amendments - but we will need to wait and see the detail before commenting on this.

5.  Impact on recipients of disability/compensation payouts

The Australian Lawyers Alliance noted on 9 April 2013 that recipients of accident compensation payments and their carers would be unfairly treated by the current proposals to tax income of more than $100,000 as those people have their payments made to a defined benefit pension account in the year of the court ordered award or settlement.  In the same year as the government has legislated for the NDIS scheme, this unforeseen consequence would be highly ironic, but presumably can be dealt with as an exemption to the proposed legislation. Again, we need to see more of the detail.

Comments specific to the SMSF superannuation sector can be found on the SMSF Professionals' Association of Australia website.

Onward to the budget on 14 May!