Over the next ten years, it is estimated that over $200Bn will be paid out as superannuation death benefits from industry and retail as well as industry super funds. If payments go to a spouse they are tax-free but what if the deceased member is the last person standing of their generation? Where do the super payments go and what is the tax rate?
In short, if the death benefit payment consists of a tax-free component, then it is tax-free. Simple.
But if the death benefit payment consists of a taxable component, then it is tax-free only when it goes to a “dependant”. However, if the death benefit payment goes directly to a non-dependant then the tax rate is 17% for the taxable component. This is on top of any realised tax gains by the Trustee in the fund in relation to the disposal of an asset to pay out a death benefit or transfer it out in-specie in satisfaction of the death benefits. For retail and industry super fund members, you may not be aware but unrealised capital gains are generally factored into unit pricing meaning a double whammy!
The upshot. We have in Australia a death tax on super payable at the time of distribution. The key to mitigating this death tax is to ensure it is only paid to persons who are dependents, and this is where a family allowance may come in and shine its light. But before we get there let’s drill down into the issue of dependency.
Note: The following discussion applies to all regulated super funds and not just SMSFs
1. Who is a Dependent?
The sole purpose test provides that the Trustee of a superannuation fund can pay death benefits to a “dependant” upon the death of a member. There are different definitions of dependent for SISA and ITAA97. A death benefit dependent for taxation purposes includes:
a deceased person’s spouse or former spouse; or
a deceased person’s child, aged less than 18; or
any other person with whom the deceased person had an interdependency relationship just before he or she died; or
any other person who was a dependant of the deceased person just before he or she died — that is a financial dependant.
It also includes someone receiving a super lump sum because the deceased died in the line of duty as a member of:
the defence force;
the Australian Federal Police;
the police force of a state or territory;
a protective service officer; or
the deceased member’s former spouse or de facto spouse.
The meaning of “interdependent relationship” has been described as “one of continuing mutual commitment to financial and emotional support between two people who reside together. The definition will also include a person with a disability who may live in an institution but is nevertheless interdependent with the deceased. For example, two elderly sisters who reside together and are interdependent will be able to receive each other’s superannuation benefits tax-free. Similarly, an adult child who resides with and cares for an elderly parent will be eligible for tax-free superannuation benefits upon the death of the parent.”
2. The Meaning of Financial Dependence
The issue of who is a financial dependant has occupied the court’s mind for more than a century in relation to workers’ compensation, taxation, and superannuation matters. For super there have been two significant cases concerning the meaning of financial dependant, for the purposes of the Superannuation Laws — Malek v FC of T 99 ATC 2294 and Faull v Superannuation Complaints Tribunal  NSWSC 1137.
In Malek’s case, Antoine Malek was aged 25 when he died. He was single, had no children, and, prior to his death, he and his widowed mother lived together. Mrs. Malek received a disability support pension of approximately $153 per week, but her accountant estimated that Antoine Malek contributed approximately $258 per week to Mrs. Malek’s living expenses for food, mortgage payments, taxi fares, medical expenses, and other bills.
The tribunal reviewed the cases on financial dependence and in its decision cited the following authoritative statement from Gibbs J of the High Court:
Gibbs J said in Aafjes v Kearney (1976) 180 CLR 1999 at page 207:
“… In Kauri Timber Co. (Tas.) Pty. Ltd. V. Reeman (1973) 128 CLR 177 at pp 188–189, I accepted that one person is dependent on another for support if the former in fact depends on the latter for support even though he does not need to do so and could have provided some or all of his necessities from another source. I adhere to that view.”
In the end, the Administrative Appeals Tribunal held that Mrs. Malek was financially dependent because the financial support she received from her son maintained her normal standard of living. Moreover, she was reliant on the regular continuous contribution of the other person to maintain that standard.
In Faull’s case, the Court held that the mother of 19-year-old Llewellyn Faull was a financial dependant of his at the time of his death, and determined that his death benefit in its entirety should be paid to her. At the time of her son’s death, Mrs. Faull had regular employment that earned her income of $30,000 pa. Her wages were supplemented by an amount of $30 per week paid by her son as board and lodging. Although the sum paid to Mrs. Faull every week by her son was small, the court stated that “the payment of that amount augmented her other income and, to that extent, she was dependent upon the deceased for the receipt of some of her income. Accordingly, she was partially dependent upon the payments made by the deceased”.
The courts have looked at financial dependence in the broad sense of the meaning and concluded that partial dependence and reliance is enough to establish financial dependence for the purposes of SISA provided the payment is ongoing and recurring.
3. Regulator Guidelines
APRA has considered the issue of financial dependence and in its payments standard guideline — APRA Guideline No.I.C.2 stated the following:
“There is no need for one person to be wholly dependent upon another for that person to be a ‘dependant’ for the purposes of the payment standards. Financial dependency can be established where a person relies wholly or in part on another for his or her means of subsistence. Nor must the recipient show a need for the money received from the deceased member in order to qualify as a dependent. Moreover, since partial financial dependency can generally be sufficient to establish a relationship of dependence, it is possible for two persons to be dependent on each other for the purposes of the payment standards.”
Given the significance to the Commissioner of Taxation of the meaning of financial dependence, expect this area of the superannuation laws to be hotly contested in the courts over the next decade or more. At Abbott & Mourly we have a few private binding ruling requests in the wings and this is indeed a hot area for PBRS.
4. The Financial Dependency Declaration
The Trustee of a superannuation fund may receive from a member of the Fund a declaration as to whom they believe is their financial dependants. This would have regard to the cases, Regulatory guidelines, and laws above. It is important for the Trustee to make the decision on all of the facts at the time of the deceased member’s death. The Dependency Declaration is, in part, evidence of that fact. You can find the dependency declaration on the LightYear Docs site here.
5. Private Binding Rulings
Parents offer their children, even well into their adult ages financial support. Some of it is direct and some indirect. Here is a great private binding ruling where the Commissioner held, based on the circumstances, that the deceased member’s adult child was financial dependants and thus tax dependants.
Note: if you have a client who has died and believe that one or more of their adult children, grandchildren, siblings, or friends are financial dependants and would like Abbott & Mourly lawyers to create a PBR for you please contact us: firstname.lastname@example.org
ATO Authorisation Number: 1051252950830
Date of advice: 17 July 2017
Subject: Superannuation death benefits
Is the Beneficiary a ‘death benefits dependent’ of the Deceased in accordance with section 302-195 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Is the Trustee of the Deceased’s Estate liable to pay tax on the superannuation lump sum death benefit payment received?Answer
This ruling applies for the following period: Income year ending 30 June 2017
The scheme commences on 1 July 201
Relevant facts and circumstances
The Beneficiary is a child of the Deceased aged over 18 years at the time of the Deceased’s death.
The Beneficiary had resided with the Deceased for a period of three months prior to the Deceased’s death.
Prior to this, the Beneficiary moved out to a rental property for one year. Apart from this period, the Beneficiary had resided with the Deceased from birth.
When the Beneficiary moved out of home for a year, the Deceased paid the applicable bond on the rental property.
At the time of the Deceased’s death, the Beneficiary was working on a part-time/casual basis.
The Deceased paid for all groceries and utilities, with the Beneficiary occasionally providing some funds towards these expenses.
In addition, the Deceased also provided the Beneficiary with cash amounts on a regular basis as well as paying the Beneficiary’s car registration.
Since the Deceased’s death, the Beneficiary has relied on interim distributions from the Deceased’s Estate to maintain their standard of living.
The Deceased’s superannuation fund (the Fund) made a lump sum superannuation death benefit payment (the Benefit) to the Trustee of the Deceased Estate.
Relevant legislative provisions
Income Tax Assessment Act 1997 section 302-10
Income Tax Assessment Act 1997 section 302-60
Income Tax Assessment Act 1997 section 302-140
Income Tax Assessment Act 1997 section 302-145
Income Tax Assessment Act 1997 section 302-195
Income Tax Assessment Act 1997 section 302-200
Reasons for Decision Summary
The Beneficiary is a ‘death benefits dependant’ of the Deceased as they were a ‘dependant’ of the Deceased just before they died, pursuant to section 302-195 of the ITAA 1997. Therefore, in accordance with section 302-60 of the ITAA 1997, the Benefit received by the Trustee of the Deceased’s Estate from the Fund is not assessable income and is not exempt income. That is, the Benefit is tax-free.
Subsection 302-195(1) of the ITAA 1997 defines a ‘death benefits dependant’ of a person who has died as:
(a) the deceased person’s *spouse or former spouse; or
(b) the deceased person’s *child, aged less than 18; or
(c) any other person with whom the deceased person had an interdependency relationship under section 302-200 just before he or she died; or
(d) any other person who was a dependant of the deceased just before he or she died.
To conclude that the Beneficiary is a ‘death benefits dependant’ of the Deceased, it must be established that the Beneficiary was a ‘dependant’ of the Deceased just before the Deceased died. Relevantly, ATO Interpretative Decision 2014/22 Income Tax: death benefits dependant- adult child caring for a terminally ill parent considered the scope of paragraph 302-195(1)(d), stating:
The definition of death benefits dependant in paragraph 302-195(1)(d) does not stipulate the nature or degree of dependency, but it is generally accepted that this refers to financial dependence and it is a condition that must exist in relation to the taxpayer at the time of the deceased’s death.
In the case of Malek (as Trustee for the Estate of Antoine Malek) v Federal Commissioner of Taxation 99 ATC 2294 (Malek) Senior Member Pascoe considered the standard of dependence which must exist, stating at paragraph 10:
In my view, the relevant financial support is that required to maintain a person’s normal standard of living and the question of fact to be answered is whether the alleged dependant was reliant on the regular continuous contribution of the other person to maintain that standard.
The Beneficiary was reliant on the Deceased for basic necessities such as food and shelter as well as the regular continuous contributions of money to maintain the standard of living to which they were accustomed. Consequently, as the Beneficiary was a financial dependant of the Deceased, it is considered the Beneficiary is a ‘death benefits dependant’ of the Deceased for the purposes of section 302-195 of the ITAA 1997.
Death benefits paid to the trustee of a deceased estate
Subsection 302-10(2) of the ITAA 1997 states that:
To the extent that 1 or more beneficiaries of the estate who were death benefits dependants of the deceased have benefited, or may be expected to benefit, from the superannuation death benefit:
(a) the benefits are 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.
It is considered that the Beneficiary is a ‘death benefits dependent’ of the Deceased. Thus, the Benefit paid to the Trustee of the Deceased’s Estate is treated as if it had been paid to a ‘death benefits dependant’ of the Deceased. Once the payment is made from the Estate to the relevant beneficiary, it will not need to be included as assessable income in that beneficiary’s tax return as the payment represents a distribution of the Estate.
Lump-sum death benefits to dependants
Section 302-60 of the ITAA 1997 states that:
A *superannuation lump sum that you receive because of the death of a person of whom you are a *death benefits dependant is not assessable income and is not *exempt income.
As such, the payment of the Benefit to the Trustee of the Deceased’s estate will be not assessable income and is not exempt income. That is, the Benefit will be tax-free.
6. The Family Allowance Agreement
In our SAPEPAA course, we go through a few more PBRs but the upshot is to be safe it is important to ensure that there is continuous, ongoing support to enhance a person’s standard of living. And it is not just adult children but the children of those children. Hence the Family Allowance Agreement provides exactly that to not just one person but the whole family. You can find the Family Allowance Agre