Monica Rule is a self-managed superannuation expert. She set up her current SMSF business in 2013 after a long career with the Australian Taxation Office (ATO).
If you ask any self-managed superannuation fund (SMSF) professional what the superannuation contributions caps are, or how much tax is payable on superannuation benefits, they would probably be able to tell you without too much thought. These are the sorts of things that an SMSF professional takes for granted.
This article is for educational purposes only and is no longer available for CPD hours.
But let’s delve a little deeper. What exactly is a superannuation contribution and when is it considered to have been made to an SMSF? And what of superannuation benefits; not only do we need to know the tax payable on benefits, but also how a benefit can be paid from an SMSF.
The aim of this article is to explain what a superannuation contribution is and when it is considered to have been made to an SMSF; as well as how a superannuation benefit can be paid from an SMSF.
The superannuation and income tax laws do not define the term ‘contribution’. However, in the Tax Office’s publication, Tax Ruling 2010/1, it states a ‘contribution’ is anything of value that increases the capital of a superannuation fund provided by a person whose purpose is to benefit one or more particular members of the fund or all of the members in general.
Of course, not every increase in the capital of an SMSF is treated as a contribution. It is necessary to consider the probable consequences of a transaction to determine whether a contribution has been made. A person’s objective purpose is taken into account and not their subjective intention.
For example, an increase in an SMSF’s capital due to income, profits and gains arising from the use of the SMSF’s assets, is not derived from someone whose purpose is to benefit one or more particular members of the SMSF. Other examples include:
an SMSF’s bank pays interest on deposits due to obligations arising under the contract it has with the SMSF and not to benefit SMSF members;
an arm’s length lender for commercial reasons forgives a loan owed by an SMSF for business purposes and not to benefit the SMSF members; or
a company pays a dividend to provide a return to its shareholders and not to benefit the members of a particular shareholder that happens to be a superannuation provider.
When a member deposits cash into their SMSF’s bank account, it is easy to conclude that a contribution is made, as the capital of their SMSF has been increased for the purpose of benefiting the member. However, there are other situations where a member may not realise they have made a contribution to their SMSF. For example:
a member transfers an asset without consideration to their SMSF;
a member satisfies an SMSF’s loan obligation as a guarantor to the loan. The guarantor’s payment extinguishes the SMSF’s liability to the lender and increases the capital of the SMSF. However, in situations where the lender exercises both the right of recourse against the asset and requires a guarantor to satisfy any difference between the value of the asset and the outstanding loan amount, then the capital of the SMSF would not be increased.
a member adds a fixture to an SMSF’s property;
a member pays the SMSF’s expenses. The payment of the expenses increases the capital of the SMSF because it extinguishes the liability of the SMSF.
The timing at which a contribution is made will determine whether the person who made the contribution is eligible to claim a tax deduction in a particular financial year, as well as whether they have exceeded their contributions caps.
In accordance with Tax Ruling 2010/1, a contribution is made when the capital of a fund is increased, and the capital of the fund is increased when an amount is received, or ownership of an asset is obtained or the fund otherwise obtains the benefit of an amount. The Ruling provides the following examples:
Cash and EFT: A cash contribution or a contribution made by an electronic funds transfer is made when the amount is received by the SMSF trustee or credited to the relevant SMSF bank account.
Cheques and promissory notes: A contribution made by money order, cheque or promissory note is made when the order, cheque or note is received by the SMSF. If a cheque is post-dated or a promissory note is payable on a date later than the day on which the note is received, then the contribution will be made on the later of the day the cheque or note is received and the date on which payment can be demanded as shown on the cheque or note. No contribution will have been made if the cheque or note is dishonoured.
Property transfers: A contribution by way of a transfer of a property is made when the SMSF obtains legal or beneficial ownership of the asset from the contributor. A beneficial ownership may be acquired earlier than legal ownership in situations where an SMSF acquires physical possession of the property. However, ownership of property may also pass on the execution of a deed of transfer of the property, notwithstanding there has been no change in the physical possession.
Legal ownership of property is normally evidenced by a system of formal registration where the SMSF is registered as the owner of the property. In the case of a sale and an acquisition of land, beneficial ownership normally passes when the purchase is settled and the buyer hands over the purchase price in exchange for a completed transfer in registrable form, together with any other necessary documents, including title deeds and discharge of mortgage that enable the transfer of title.
Share transfers: A contribution of shares in a company is made when the legal ownership of the shares is recognised by the SMSF’s name being registered in the company’s share register. This is for shares in a publicly listed company affected through the Clearing House Electronic Sub-register System (CHESS). However, beneficial ownership of shares in an Australian Stock Exchange listed company can be affected through an off-market share transfer, when the SMSF obtains a properly executed off-market transfer in registrable form.
Whether a contribution is made when beneficial ownership of property passes is determined on a case-by-case basis. An SMSF trustee who seeks to argue that the contribution of property occurs when the beneficial – not legal ownership – of the asset passes to the SMSF, must retain sufficient evidence of the relevant transactions and events to precisely identify when the change of beneficial ownership occurs.
Evidence can include: trustee minutes, the relevant transfer forms, and any other record of when the transfer took place. In the absence of evidence, the contribution will be treated as made when the SMSF obtains legal ownership of the property.
Improvements to an asset: A contribution is made when the capital of the SMSF is increased because of the increase in value of the asset due to the improvements done on the SMSF’s asset.
Payment of a liability: A contribution is made when a person satisfies an SMSF’s liability that results in the SMSF’s capital being increased.
Contributions made by paying the SMSF’s expense: A member paid accounting and audit fees belonging to their SMSF using their own money and did not claim reimbursement from the SMSF. By satisfying a liability of the SMSF, the member has indirectly increased the capital of the SMSF by increasing the benefits the member would ultimately receive from the SMSF. Therefore, the member made a contribution to the SMSF when they paid the accounting and audit fees.
In-specie (property) contribution: A member, who is the sole director of the corporate trustee of his SMSF, completes the necessary land transfer forms to transfer the business property he owns to his SMSF. He takes possession of the land transfer forms and the relevant title deeds in registrable form necessary to obtain registration of title to the land, in his capacity as the director of the corporate trustee of his SMSF on 29 June 2017. He lodges them with the registrar of land titles on 2 July 2017. The member has made an in-specie contribution to the SMSF on 29 June 2017.
In-specie (shares) contribution: On 26 June 2017, an SMSF member signs an off-market share transfer form to transfer listed shares he owns to his SMSF. However, the member leaves certain parts of the form blank for completion by his stock broker. The member posts the transfer form to his broker on 26 June. The broker adds the omitted information on 2 July 2017, and completes the transfer through CHESS. The SMSF trustee is registered as a shareholder on 5 July 2017. The member’s in-specie contribution is made on 2 July, as it is the day the relevant transfer has been completed in a registrable form.
Once an SMSF member has satisfied a condition of release under the superannuation law, such as reaching their preservation age or reached age 65, then they can access their super savings from their SMSF. As to what form (e.g. lump sum or an income stream) their superannuation benefit can be paid from their SMSF will depend on the SMSF Trust Deed.
A lump sum superannuation benefit is normally a one-time payment; whereas, an income stream (e.g. pension) superannuation benefit is a series of periodic payments made over an identifiable period of time, either at the same or in recurring intervals (e.g. weekly, monthly, quarterly, half yearly or annually).
A lump sum superannuation benefit can be paid either in cash or in-specie, but an income stream superannuation benefit can only be paid in cash. This is because the definition of a ‘lump sum’ under the superannuation law includes an asset. However, there is no equivalent definition for an income stream.
Under the current income tax law (Pre 1 July 2017), when an income stream is partially commuted, the member or a dependant beneficiary may make an election for the payment of the partial commutation not to be treated as a superannuation income stream benefit and instead be treated as a lump sum benefit.
Therefore, if the election is made, the payment from the partial commutation of an income stream is a super lump sum for income tax purposes and the lump sum can be paid either in-specie or in cash and taxed as a lump sum super benefit. If the election is not made, then the payment is a superannuation income stream benefit and cannot be paid in-specie.
From 1 July 2017, a partial commutation of a pension will be treated as a lump sum. The law will be changed so that a lump sum payment arising from the partial commutation of a pension will no longer count towards the required minimum pension payment.
Can a lump sum benefit be paid in instalments?
A lump sum superannuation benefit can be paid in any instalments, as long as the member has met a condition of release and is entitled to access their benefit from their SMSF.
However, when it comes to payment of a lump sum death benefit to the deceased’s beneficiaries, the superannuation law requires that the death benefit be paid either as a single lump sum, or an interim lump sum and a final sum.
This means, a lump sum death benefit can only be paid in one or two instalments. An SMSF cannot ‘drip feed’ death benefits to beneficiaries when the SMSF’s assets are sold and cash becomes available.
Can a superannuation benefit be made using a journal entry?
The term ‘payment’ is not defined in the law. Court cases have confirmed that a payment normally occurs where two parties both have a present liability or legal obligation to the other and by agreement they set off the liabilities against each other using a journal entry.
However, where an SMSF has a present obligation to pay a member or a beneficiary either a superannuation income stream or a lump sum, there is no present obligation or liability to the SMSF on the part of the member or the beneficiary and therefore, no mutual obligation exists. As a result, a superannuation benefit cannot be made with a journal entry.
The Tax Office has stated in its Interpretative Decision 2015/23 that where the benefits of a deceased member of an SMSF are to be paid as a death benefit to the deceased’s beneficiary, the superannuation law does not allow the benefit to be transferred to the beneficiary’s superannuation account simply by way of journal entries in the books of the SMSF. The death benefit must actually be paid to the beneficiary by transfer of ownership of the deceased member’s assets to the beneficiary.
This means payment involves an SMSF making a cash or in-specie payment that reduces the member’s benefit in the SMSF. Transferring assets or cash to the beneficiary from the deceased member’s superannuation account via a journal entry would not amount to cashing benefits and does not satisfy the law.
In-specie lump sum payment: Alan and Emily are members of their SMSF. They have total accumulated superannuation savings of $800,000, which consists of a residential property valued at $500,000, listed shares worth $250,000 and $50,000 cash. Alan is aged 66 and decides to retire. The amount of retirement benefit that Alan is entitled to from his SMSF is $550,000.
Alan and Emily have always planned to sell their existing home in the city and move closer to the beach once they retire. They would like to move into the residential property owned by their SMSF, as it would be an ideal home to live in.
The SMSF trustee pays Alan his lump sum superannuation benefit consisting of the residential property $500,000 and cash of $50,000. As there has been a change of legal ownership of the residential property, the SMSF will pay tax on any capital gains from the transfer of the property from the SMSF to Alan.
Partial commutation of a pension: Alan decides to retire and requests his SMSF to pay his retirement benefit as an account-based pension. Alan commenced his pension on 1 July 2015. As Alan is aged 66, the minimum pension that his SMSF is required to pay in the 2015-16 financial year is $27,500 ($550,000 x 5%).
Then in the 2016-17 financial year, Alan decides he would like to partially commute his pension. The minimum amount of pension the SMSF is required to pay Alan is calculated by multiplying the balance of his pension account by 5 per cent.
Assume the balance of Alan’s pension account is $26,125 ($522,500 x 5%) and a total of $16,450 pension instalments have already been paid to Alan during the financial year. Alan decides to partially commute his pension and withdraws a lump sum of $80,000. The partial commutation payment is a lump sum and counts towards the minimum pension amounts regardless of whether the payment is made in cash or in specie.
If Alan wants the payment to be treated as a lump sum, he can make an election under the taxation law. It does not matter if the payment is taxed as either a pension or a lump sum in Alan’s hand. As long as at least the minimum amount of pension is paid from the SMSF and is appropriately documented, the SMSF will not lose the tax exemption associated with paying an income stream. The SMSF pays Alan’s lump sum payment of $80,000 as an in specie transfer of listed shares owned by the SMSF.
Please be aware that if Alan partially commutes his pension anytime from
1 July 2017, the partial commutation will not count towards his minimum pension payment requirement. The partial commutation of the pension will be treated as a lump sum superannuation benefit.
Full commutation of a pension: Alan decides to fully commute his pension on 31 December 2017. However, there is a requirement under the superannuation law that if an account-based pension is fully commuted, then the minimum amount required to remain in the SMSF is a pro-rata amount to the time of the commutation.
Payment made as a result of a full commutation cannot count towards the minimum annual pension amounts, as the account-based pension ceases before the full commutation payment is made.
Therefore, the minimum amount of pension required to be paid from Alan’s pension account is $13,098 ($26,125 x 183/365 days pro-rata). Alan’s superannuation interest remaining in his SMSF can be paid out to Alan as either an in-specie lump sum payment and/or a cash payment.
Lump sum death benefit: Pam and Michael are members of their SMSF. Pam becomes seriously ill and after some time, passes away. Michael manages a personal investment portfolio and would like Pam’s death benefit lump sum be paid to him in three instalments to suit his financial commitments.
Unfortunately, Michael cannot request the payment in three instalments as this would not comply with the superannuation law. Michael would need to arrange his financial commitments to suit the maximum of two instalments.
Monica Rule is an SMSF specialist and author of ‘The Self Managed Super Handbook – Superannuation Law for SMSFs in plain English’.
For 0.5 CPD Hours (Critical Thinking), go to fpa.com.au/cpdmonthly and answer the following questions correctly.
1. The Tax Office’s interpretation of a ‘superannuation contribution’ is:
Any cash paid to an SMSF.
Anything of value that increases the capital of an SMSF provided by a person whose purpose is to benefit one or more particular SMSF members.
Money rolled-over from one superannuation account to another within an SMSF.
Interest income received on an SMSF’s bank account.
2. A contribution is treated as ‘received’ by an SMSF at the time:
A cheque is posted to the SMSF trustee.
The capital of the SMSF is increased.
The key to a property is given to the SMSF trustee.
A verbal agreement is entered into.
3. An income stream benefit can only be paid:
Partly in cash and partly using assets.
4. A lump sum death benefit can only be paid:
In any number of instalments.
In one or two instalments.
Via a journal entry.
5. Law changes from 1 July 2017 will treat partial commutation of a pension as: