Out of the Frying Pan and into the Fire

After the Royal Commission put the entire finance industry on notice last year, many were hopeful that the worst of the drama surrounding the Australian economy was behind us. However, the economic health of our country has been thrown into question by the International Monetary Fund (IMF), which points out that the Australian economy is performing at the slowest pace since the global financial crisis over a decade ago. Furthermore, between Australia’s last recession in 1991 and 2018, the pace of growth was 3.2% – more than double the current rate of 1.4% for the year to 30 June.

To counteract this, it’s never been more important to get your tax position in order. There are numerous elements to consider in the process and to help, we continue to shine a light on some practices and evolving circumstances that can improve your taxation outcomes for the year.

In this edition of PULSE, we take a look at a case study centred on Division 7A Loan Agreements to investigate how they could potentially impact your financial strategy. We also discuss how our new streamlined monthly direct debit model can make your life easier. Finally, we provide some clarity on the often-misunderstood world of death benefits and the implications they can have on an estate.

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Division 7A Loan Agreements

A Division 7A is a set of rules that applies to disguised distributions (i.e. loans and other such arrangements). When enacted, these rules treat such agreements as though they are actual distributions of income and even go so far as to impose penalties by denying the individual of credit for any tax paid by their company.

Essentially, what this all boils down to is, in the event Division 7A applies, the individual who receives the funds from the company disguised as loans or other payments may be liable to tax at their marginal tax rate, which could be as high as 45%. Logically speaking, this sum of money may have already been taxed to the small business entity at its corporate tax rate of 27.5%. This could be a nightmare outcome by any assessment, however, if the issue is addressed in a timely fashion there is hope.

Do you have any loans as assets on the balance sheet of your company?

KKQY Case Study: Varying Division 7A Loan Agreements

KKQY and FCT (2019) is a case centred on a taxpayer who entered into a loan agreement with a company they were associated with in 2005. The original loan agreement did not comply with Division 7A, so another agreement that met the requirements was drawn up and signed in 2007.

In a subsequent financial year, the taxpayer failed to service the minimum loan repayments, to which the ATO responded by including this shortfall with the taxpayer’s assessable income. The taxpayer argued the position that, because the original loan agreement did not comply with Division 7A, a deemed dividend had already arisen in 2005 in relation to the full loan amount and anything outstanding amount was therefore no longer subject to the Division 7A rules and regulations.

The ATO adopted the position that the 2007 agreement in effect changed the terms of the loan to such an extent that it was not, in fact, a variation of the 2005 agreement and instead eradicated and replaced it. As a result, a new loan that was compliant with Division 7A was entered into in 2007 and the minimum loan repayment requirements applied.

This case study and the decision handed down highlight the care that must be taken in order to ensure that any changes to the terms of loans that are not subject to Division 7A do not “refresh” and alter the loan to the extent that Division 7A must be applied.

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Direct Debit Model for Tax & Accounting Services

As a financial services firm, one of our greatest aims is to become your trusted adviser across every element that impacts your fiscal wellbeing. We are not merely a transactional based business. Rather, we are focused on long-term relationships that deliver the best possible outcomes across the full breadth of your wealth strategy, because we want to be the first and only phone call you make for any and all of your financial needs.

So, as part of our commitment to client service, making your life easier and assisting with every aspect of your wealth creation and management strategies, we are now offering a subscription-based model with direct debit billing for taxation and accounting services.

As a firm we have decided to offer this service while formalising our client engagement agreements for the following reasons:

• It provides a fixed monthly fee with no surprises.
• It allows us to collaborate more closely with clients and be proactive with advice throughout the year as opposed to being restricted to the end of the tax year when limited strategies can be applied.
• Monthly payments enable better cash flow for clients as opposed to annual lump sum payments.
• It establishes a clear understanding of the elements of engagement – what will you receive and what are you entitled to.
• It assists in avoiding uncertainty and misunderstandings, especially over fees and scope of work to be completed.
• It aligns with our obligations under the Code of Professional Conduct.

This model is designed to be transparent and easy to follow, giving you peace of mind that our team of accountants are working for your best interests year-round. Plus, our infrastructure allows you to set up your direct debit immediately and you can cancel at any time without fees or penalties.

If you have any questions or would like to set up your direct debit facility today, contact us on (02) 9997 4647.

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Understanding the Tax Treatment of Death Benefits

Extremely complex and often misunderstood, the tax treatment of death benefits paid from an SMSF to a deceased member’s estate are tricky terrain to navigate. Australian tax law includes what is known as a ‘look through’ provision for death benefits paid to an estate or a personal legal representative that is the executor of a will or the administrator in instances of intestacy.

But what are the key criteria of these ‘look through’ provisions and what is the flow on effect for tax treatment?

‘Look Through’ Provisions and Death Benefits Paid to the Estate

Section 302-10 of the Tax Act (1997) outlines the relevant provisions that deal with death benefits paid to an estate.

Specifically, these provisions state that where beneficiaries of the estate identified as ‘death benefits dependants of the deceased’ have or expect to receive funds from the superannuation death benefit:

(a)  the benefit is treated as if it had been paid to you as a person who was a death benefits dependant of the deceased; and

(b)  the benefit is taken to be income to which no beneficiary is presently entitled.

Following on from this, in the event that one or more beneficiaries of the estate who were not ‘death benefits dependants’ of the deceased have benefited, or may be expected to benefit, from the superannuation death benefit:

(a)  the benefit is treated as if it had been paid to you as a person who wasnot a death benefits dependant of the deceased; and

(b)  the benefit is taken to be income to which no beneficiary is presently entitled.

It is important to note that The Tax Act defines a ‘death benefits dependant’ broadly as:

• the deceased person’s spouse or former spouse;
• the deceased person’s child, aged less than 18;
• any other person with whom the deceased person was in an interdependency relationship with just before he or she died; or
• any other person who was a dependant of the deceased person just before he or she died.

It’s worth noting that this is different to how the SIS Act 1993 defines a death benefits dependant. This may create an issue if appropriate measures are not taken to ensure the person who is potentially a tax dependant is also a dependant for Superannuation purposes.

Tax Treatment

The tax treatment of any death benefits proceeds that are paid to the estate is contingent upon the extent to which death benefit dependants have benefited or may be expected to benefit from the proceeds.

To determine this it must be calculated, and once the calculation is concluded, any proceeds paid to the estate from which death benefits dependants have benefited or may be expected to benefit:

• are treated as if they had been paid to a death benefits dependant of the deceased; and
• are not included in the assessable income of the estate (ITAA 1997 section 302-60).

For any death benefits paid to the estate where death benefits dependants do not benefit or may not be expected to benefit, the tax treatment depends on the nature of the lump sum amount paid to the deceased’s estate. Consequently, the tax treatment of the super proceeds is as follows (based on the nature of the lump sum):

• Any tax-free component of the amount is not included in the assessable income of the deceased’s estate (ITAA 1997 section 302‑140).
• Any taxable component (element taxed in the SMSF) of the amount is included in the assessable income of the deceased’s estate, but the estate is entitled to a tax offset to ensure that the rate of income tax does not exceed 15% (ITAA 1997 section 302‑145(2)).
• Any taxable component (element untaxed in the SMSF) of the amount would be included in the assessable income of the deceased’s estate and the estate would be entitled to a tax offset to ensure that the rate of income tax does not exceed 30% (ITAA 1997 section 302‑145(3)).

Within the context of SMSFs, untaxed elements are rare and typically only a concern if deductions were ever claimed in respect of policy premiums for a life insurance policy held in the SMSF.

To help make all this clearer, the following case study highlights the ‘look through’ provision and the subsequent impacts on tax treatment.

Case Study: ‘Look Through’ Provisions and Death Benefits

Andrew was 68 years old when he died. He was a member of ABC123 Superannuation Fund. Andrew did not complete a (binding or non-binding) death benefit nomination in relation to entitlements in the ABC123 Superannuation Fund prior to his death.

As a result, the trustee of the ABC123 Superannuation Fund exercises discretion and pays Andrew’s death benefits to Andrew’s estate pursuant to the governing rules of the fund. A sum of $100,000 that is paid to the estate comprises 50% tax free component and 50% taxable component (which is taxed in the Fund).

The beneficiaries named in Andrew’s will are his wife Dana, his two sons Barry (16 years old) and Glen (14 years old) and his best friend James (50 years old and not a dependant for tax purposes).

The will outlines that Andrew’s superannuation death benefits proceeds are to be divided as follows: Dana ($90,000) and James ($10,000).

Applying the ‘look through’ provision, Dana, Barry and Glen would meet the definition of death benefits dependant under section 302-195 of the ITAA 1997. Despite this, only Dana may be expected to benefit from the superannuation death benefits proceeds. Accordingly, the $90,000 to be paid to Dana would not be included in the assessable income of the estate.

The $10,000 to be paid to James will comprise $5,000 tax free component (not included in Andrew’s estate) and $5,000 taxable component (taxed in the Fund and included as assessable income of Andrew’s estate). However, the estate is entitled to a tax offset to ensure that the rate of income tax does not exceed 15% pursuant to section 302‑145(2) of the ITAA 1997.

Final Word

When any funds or proceeds from a superannuation account are paid to an estate, the tax payable on death benefit proceeds will depend on whether the recipient of the superannuation proceeds is a death benefits dependant. These are murky waters at best and in instances like this where tax law gets extremely tricky, expert advice should be obtained.

If you have a question about tax treatments applicable to your circumstances, now is the time to get in touch. Our team of dedicated accountants is here for all your tax and accounting needs, utilising our experience and understanding of the Australian taxation landscape to help you get the most out of your wealth creation and management strategies. Call Chetan and his team today on (02) 9997 4647.