SMSF Technical Education & Strategies

 

Strategy - The Anti Detriment Deduction

by David Busoli
Cavendish Superannuation

Capital gains tax on a member’s death is a consideration for an SMSF if a pension cannot be paid to surviving beneficiaries. This is particularly important when the last surviving parent dies and the member account must pay out to a surviving child or to the estate. It is possible that significant capital gains tax liabilities may arise at this point requiring a consideration of available tax deductions to the Fund.

Section 295-485 provides a Fund with the ability to claim a deduction based on an increased amount of superannuation lump sum death benefit. This anti-detriment increased amount of death benefit is a result of the 1988 introduction of a mechanism to allow the Fund to claim the tax paid on contributions.It applies to any death benefit paid to a spouse, former spouse (via the Estate) or child of the deceased member and ensures the payment to the recipient is the amount they could have expected to receive had no tax been paid on the contributions.

 

To be entitled to the deduction the Fund must first pay the increased death benefit which is a benefit additional to that sourced from the deceased member’s account. The Fund is entitled to a deduction which is intended to compensate for contributions tax once it has been applied to taxable income at 15%. This deduction is available irrespective of the deceased’s age.

 

Simplistically, if the fund had received $100,000 in tax deductible contributions it would have paid $15,000 in contributions tax so an anti-detriment payment of $15,000 as a lump sum payment to a spouse or child of the deceased will provide the Fund with a $100,000 tax deduction. This will create a saving of $15,000 in tax on the next $100,000 in taxable income the Fund receives including from concessional contributions. Unless the Fund can use the deduction the compensation mechanism fails.

 

The Tax saving amount must be certified by the Fund’s auditor as being the amount of benefit reduction due to the tax on taxable contributions. It can also include a consideration for the loss of earnings on the tax paid. As many Funds do not have the necessary historical information available for the auditor to certify, the original explanatory memorandum provided an additional formula to calculate the tax saving amount.

 

Whilst this formula can still be used, a subsequent formula has been released via ATO Interpretive Decision 2007/219. This subsequent formula results in an amount that is at least the equivalent or greater than the explanatory memorandum formula amount and is the basis for our example.

 

The formula to calculate the increase in the death benefit lump sum is as follows:

 

(0.15 x P)
------------------ x C
(R - 0.15 x P)

 

P = Number of days in R that occur after 30 June 1988
R = Total number of days in the service period post 30 June 1983
C = Taxable component of the lump sum (excluding any insurance proceeds having claimed 295-465 or 295-470 prior to the addition of the anti-detriment amount).

 

Example

Bob dies and the Fund elects to pay an anti detriment amount to his wife Anne.

• Bob is 42, born 1/7/1960, died on1/7/2002
• Eligible service date 1/7/1992
• Member benefit is $1,000,000
• Insurance proceeds included in the benefit is $500,000
• All taxed element

 

The increased death benefit would be:

 

(0.15 x 10)
......................... x ($1,000,000 – $500,0000) = $88,235
(10 - 0.15 x 10)

The tax deduction gained by paying this increased benefit is:

 

$88,235

................. = $588,233
0.15

 

Note that the actual number of days is required for the purpose of calculating the final numbers.

 

If the Fund is able to pay the extra death benefit of $88,235 in full the Fund will gain the huge tax deduction of $588,233.

 

The greatest problem facing a fund wishing to pay an anti-detriment payment is that the claimable tax deduction is only allowed after the anti-detriment payment has been made. Therefore the Fund must have the ability to pay that amount in addition to the actual member balance. A further issue is that the anti-detriment payment must be paid in full. A partial payment is not allowed. Special care should be taken to ensure the calculation is correct as the ATO are highly likely to audit any Fund that seeks to claim an anti-detriment deduction and the deduction will be disallowed if the payment is not correct.

 

This payment creates a difficulty for SMSF’s as the Fund cannot reduce another member’s entitlement to pay the increased death benefit. Essentially the payment can only come from life insurance, reserves or an investment by other members in a future tax benefit.

 

Life insurance proceeds may be used to create an immediate reserve subject to the Trust Deed. A Deed which requires the proceeds of a life insurance policy to be credited to the deceased member’s account will defeat this objective. Reserves may be established over a period of time from surplus Fund proceeds. This will require some forward planning. A Self Insurance Reserve may hasten the process.

 

The use of a Future Tax Benefit investment by other Fund members is another potential solution. Essentially this entails paying the anti-detriment payment out of other member’s accounts and justifying this as an investment. This has been used effectively in the past but this may change when the ATO turns its focus onto investment strategies as I believe it is difficult to justify such an investment as a legitimate investment of the Fund given that it will never return a profit and may not even return the principal sum unless there are sufficient taxable profits in the Fund to offset the tax deduction.

 

Another issue is that the payment of an anti-detriment payment will, under most circumstances, be counted against the concessional caps of the deceased. There is no contribution tax levied but there will be tax payable if the caps are breached. Funds considering creating an anti-detriment reserve or insurance reserve must investigate whether the allocation from the reserve will create an amount to be counted against the deceased members concessional contribution cap.

 

Given that the exact amount of the anti-detriment amount is what must be paid the use of one of the other calculation methods could yield a lower result. This may be more acceptable when cap considerations are considered. A lower amount may also be achieved by adjusting the amount of lump sum paid to a spouse by applying more of the death benefit proceeds to the provision of a pension.

 

Any unused deduction can be carried forward to be used by the Fund in future though it will gradually reduce if there are pension members in the Fund as any taxable profit earned in a pension account will be reduced by the carried forward loss before the nil tax rate is applied. Consideration should therefore be given to rolling pension members to an alternative Fund.

 

Anti-detriment payments represent a valuable tool in reducing the Fund’s tax liability but great care should be taken in their application.

 

David Busoli runs the Queensland office for Cavendish Superannuation, Australia's largest superannuation administration company. He is one of the most experienced SMSF specialists in the country, and has been at the forefront of SMSF administration for many years. Much of his time these days as part of the team at Cavendish Superannuation is devoted to educating professional financial service providers including financial planners, accountants, lawyers and stock brokers operating in the self managed super sector. He often addresses public forums and has addressed SMSF conferences for Kaplan and SPAA, PD days for numerous dealers, stock brokers and banks, the Australian Tax Institute, the Australian Investors Association and the Qld Law Society.

 

Trustees should obtain relevant and specific professional advice before making any decisions. The information contained herein does not take into account the investment objectives, financial situation or needs of any particular investor. Before making a decision investors should consider, with or without the assistance of a licensed advisor, whether the information contained herein is appropriate in light of their particular needs, objectives and financial circumstances.

 

The articles herein contain the current opinions of the author only. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of the author.