SMSF Online Update

DAN BUTLER

Director, DBA Lawyers

Ph: 03 9092 9400

Web: dbalawyers.com.au  Twitter: @DBALawyers

April 2015

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Legal noticeThese notes are a general guide only based on our view of the law as of 10 April 2015. They are no substitute for expert advice. Anyone seeking to rely on these notes should obtain expert advice to confirm particular issues especially as the law is subject to ongoing changes and substantial penalties can be imposed. We are not licensed to provide financial product advice under the Corporations Act 2001 (Cth). Copyright resides in DBA unless another source is noted.

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Overview• ATO likely approach to non‐commercial related party LRBAs in prior FYs

• BDBNs after a string of court cases on BDBNs and second spouses?

• Documentation when an SMSF fails the minimum payment test for a pension?

• ATO case study on disqualified trustees

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LRBAs

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LRBAs Current status re: non‐commercial related party (‘NCRP’) LRBAs:

• ATO ID 2014/39 & 40 issue confirming non‐arm’s length income (‘NALI’) will be applied to NCRP LRBAs, eg, nil interest and other ‘loose’ terms

• ATO factsheet on website confirms:• These  ATO IDs (39 & 40) should not be seen as concluding that all related party LRBAs give rise to NALI. Things we are likely to consider in that context include the:

• nature of the acquirable asset• amount borrowed• term of the loan• loan‐to‐value ratio• interest rate charged• regularity and frequency of principal repayments required• security• extent to which the• loan has operated in accordance with its terms.

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LRBAsExtract from ATO website 

To be able to demonstrate that NALI does not arise, a fund trustee entering into an LRBA with a related‐party borrower should obtain and keep documentation that enables them to establish that the terms of the loan, taken together, and the ongoing operation of the loan are consistent with what an arm’s length lender dealing at arm’s length would accept in relation to the particular borrowing by the fund trustee.

The matters listed above, taken together, would need to be shown to be consistent with what an arm’s length lender dealing at arm’s length would accept in relation to the particular borrowing by the fund trustee. Note that in relation to particular circumstances, there may be other matters that would also be relevant.

[Emphasis added]

https://www.ato.gov.au/Super/Self‐managed‐super‐funds/In‐detail/News/Non‐commercial‐limited‐recourse‐borrowing‐arrangements/

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LRBAs

• There were some 15+ negative private binding rulings (‘PBR’) issued and all had nil interest and most of these PBRs also had other ‘loose’ terms. 3 of these PBRs stated that Part IVA ITAA 1936 would apply if NALI did not. (This was after 2 initial positive NCRP LRBA PBRs issued to ‘lucky SMSFs’)

• ATO ID 2010/162 confirmed no contravention of s109 SISA

• ATO confirmed: no contribution would result from a saving in an outgoing

• The Financial Systems Inquiry (‘FSI’) recommended:

Remove the exception to the general prohibition on direct borrowing for limited recourse borrowing arrangements by superannuation funds.

… funds with existing borrowings should be permitted to maintain those borrowings.

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LRBAs• Thus, NCRP LRBAs are at risk of NALI going back some years

• DBA Lawyers: therefore sought informal ATO input on whether SMSFs were only prospectively required to benchmark with arm’s‐length terms (provided they were not under ATO scrutiny for other ‘skeletons in the closet’)

• ATO: is unlikely to follow up cases that have self corrected. The legal position is NALI can apply from the start of the arrangement and if we are forced to undertake an audit this would be considered. It's likely the ATO will keep to the formal legal position without qualifying how this will apply

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LRBAs• The ATO also added that it was its desire that SMSFs self corrected on a retrospective basis

• Generally prior assessments can be amended for up to 4 years from the date of assessment (usually, the date of lodgement of an SMSF tax return) absence fraud or evasion where the ATO can go back indefinitely

• Ideally, SMSF tax returns should be prepared on the basis that there is sufficient disclosure so there would not be fraud or evasion 

• Tax agents must lodge returns they know are ‘correct’ under the Tax Agents Services Act 2009 (Cth) (‘TASA’) s30‐10 sets out The Code of Professional Conduct (‘Code’)

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LRBAs

Extracts from the Code in s30‐10:

(7) You must ensure that a *tax agent service that you provide, or that is provided on your behalf, is provided competently.

(8) You must maintain knowledge and skills relevant to the *tax agent service  that you provide.

(10) You must take reasonable care to ensure that *taxation laws are applied correctly to the circumstances in relation to which you are providing advice to a client

(12) You must advise your client of the client's rights and obligations under the * taxation laws that are materially related to the *tax agent services you provide.

[Emphasis added]

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LRBAs

• Thus, advisers must ensure they carefully consider the client’s interests and the obligations that they have under applicable law

• Most accountants being tax agents are covered by TASA

• Many financial planners are now also covered by TASA

• Broadly, auditors are concerned the accounts accord to the prescribed regulatory requirements and the accounts present fairly an SMSF’s financial position

• If NALi was applicable and materially misstated the accounts, then an auditor may qualify but may not necessarily need to lodge an auditor contravention report

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BDBNs

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BDBNsA brief recap on the history of BDBNs:

• Introduced in mid 1999 and previously deeds generally left the death payment to the trustee’s discretion

• These are not mandatory but useful when greater certainty is needed, eg, 2nd spouse, difficulty with children or dependant who may be bankrupt, etc

• DBA Lawyers focus on control and succession thereto and includes numerous strategies in its SMSF documents, eg, successor trustee/director

• There is no great body of law or safeguarding legislation as with wills

• We have now reached a point of understanding with BDBNs with the decided case law which we will now briefly examine

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BDBNsBelow are very broad observations for BDBNs from these cases:• Katz v Grossman [2005] NSWSC 934 – a Co trustee and BDBN could have saved this dispute where the daughter helped herself to dad’s benefit

• Donovan v Donovan [2009] QSC 26 – the letter was not a BDBN but the judge commented (non‐binding) reg 6.17° SISR applied

• Re Australian Motors SA Pty Ltd Staff Superannuation Fund [2010] SASC 62 – the trustee was right in seeking court clarification (preliminary hearing). A BDBN that did not follow the form in an employer‐fund’s deed

• Wooster v Morris [2013] VSC 594 – the second spouse disputed the BDBN• Ioppolo & Hesford v Conti [2013] WASC 389 – the 2 daughters were not allowed to represent their deceased mother as her LPR. There was no upsetting of Augusta’s exercise of discretion of his newly appointed Co trustee to pay himself the death benefit

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BDBNs• Munro v Munro [2015] QSC 61 is the latest case involving a BDBN that was held not to be binding

• Barrie Munro, a former lawyer, died in August 2011 

• He excecuted a BDBN on 22‐9‐2009 and was survived by Suzie (2ndspouse) and 2 daughters from prior marriage

• The BDBN was prepared by his accountant and two prior similar BDBNs were prepared by his accountant/financial planner

• Suzie appointed her daughter Ms Pooley as co‐trustee of the SMSF

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BDBNs• The BDBN form defined a ‘nominated beneficiary’ as:

Each nominated beneficiary must be your spouse …, child …, financial dependant, interdependent or the executor of your estate (as stated in your will). When you nominate your executor you should enter legal personal representative in the relation column. [Emphasis added]

• Barrie’s BDBN directed the Fund trustees to pay his death benefits on his death to ‘Trustee of Deceased Estate’

• The SMSF trustees considered the BDBN to be invalid and wanted to exercise their discretion in relation to the payment of Barrie’s death benefit

• Can you guess who to? 

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BDBNsMullins J at [35] to [36] stated:

[35] Although SMSFD 2008/3 is not binding on the court (or the Commissioner of Taxation) it sets out a logical approach to the construction of s 59 of the SIS Act which I consider correct and adopt for the purpose of determining the applicability of reg 6.17A of the SIS Regulations to the fund.[36] As s 59(1) of the SIS Act does not apply to a [SMSF], the exception to the application of s 59(1) found in s 59(1A) also does not apply to a [SMSF]. Regulation 6.17A sets out the conditions for the purpose of s 59(1A) for the payment of a death benefit after the death of a member, but in view of the exclusion of a [SMSF] from the operation of s 59(1), those conditions do not apply by virtue of either the SIS Act or the SIS Regulations to a [SMSF].

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BDBNs• Mullins J distinguished Donovan’s case which indicated in Fryberg J’s non‐binding comments (ie, ‘obiter dictum’ compared to the binding reasons or ‘ratio decidendi’ of a judgement) that the SMSF deed in Donovan’s case imported the requirements of reg6.17A 

• In contrast, inMunro’s case, it was noted that the definition of the ‘Statutory Requirements’ in the Donovan deed was broad and stated:… means the requirements imposed under any law or by any Statutory Authority which must be satisfied by a superannuation fund in order to qualify for income tax concessions …

• Again, Mullins J, distinguishedMunro’s case from Donovan’s case, and noted the reason for this distinction as:[39] In contrast, the definition of “Relevant Requirements” for the purpose of the fund is limited to any requirement the trustee of the fund or the subject trust deed must comply with in order to avoid a contravention of the requirements or in order for the fund to qualify for concessional taxation treatment as a complying super fund. The “Relevant Requirements” are defined as requirements only if they apply to the fund and therefore do not import reg 6.17A which does not apply to the fund.[Emphasis added]

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BDBNs• Munro’s case clarifies that SMSF BDBNs are not subject to reg 6.17A if the deed is clear

• In Donovan’s case, the ‘Statutory Requirements’ incorporated virtually all the requirements imposed under any law on superannuation funds

• In Munro’s case, the ‘Relevant Requirements’ incorporated only those that must be complied with

• ‘Deeming provisions’ in SMSF deeds are important and vary from supplier to supplier. You should check your deeds to see how they stack up

• Thus, a BDBN for an SMSF member can be non‐lapsing and last indefinitely (Qld Supreme Court authority)

• This is consistent with the view DBA Lawyers’ have held for many years

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BDBNs• Munro’s case also confirms the need for strict compliance with the SMSF deed and BDBN form. These issues were canvassed:

• Reg 6.22 only allows payment to a dependant or LPR • The definition of ‘LPR’ in s10 SISA means, relevantly here, the executor of the will• Reg 6.17A(4)(a) provides: ‘the person, or each of the persons, mentioned in the notice is the legal personal representative or a dependant of the member;

• An executor only becomes a ‘trustee’ after a deceased estate has been administered, ie, the executor’s role converts to a trustee of a testamentary trust after the assets and liabilities are ascertained and the beneficiaries become presently entitled. In FCT v Whiting (1943) 68 CLR 199 at [215]–[216] the High Court concluded:Until an estate has been fully administered by payment or provision for the payment of funeral and testamentary expenses, death duties, debts, annuities, and legacies and the amount of the residue thereby ascertained, the income of the residuary estate is the income of the executors and not of the residuary beneficiaries.

Thus, the ‘Trustee of Deceased Estate’ was not in accord with the term LPR as per the deed (cl 31.2) and BDBN form 

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BDBNs• Munro does away with a great deal of uncertainty as many SMSF suppliers have gone for a 3 year lapsing BDBN and compliance with SISA

• DBA Lawyers experience over the past 15 years is that many BDBNs fail as they are older than 3 years and are not renewed in time. Moreover, given Munro, we are concerned that many BDBNs are now  uncertain under many deeds

• Note that SMSF deeds and BDBN forms are not a generic product and many are unsatisfactory. Many are easily challenged due to poor wording such as:

• ‘the BDBN is only binding if it’s to the trustee’s satisfaction’

• Assume you are the 2nd spouse how would you challenge this?

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BDBNs• Why the BDBN was invalid in Munro’s:[44]  The nomination form must be construed on its face and having regard to its 

purpose. The applicants relied on the terms of the will to assist in construing the nomination. It is not appropriate to construe the nomination form by reference to the will when the nomination is for the purpose of payment of the death benefit from the fund

[45]  Clause 31.2 regulates both the form and substance of the nomination. There is no power given to the trustees under the trust deed or otherwise to dispense with compliance with the conditions set in clause 31.2 for a [BDBN]. It is only a nomination for the purpose of clause 31.2, if all the conditions set out in that clause are met by the nomination

• Finally, note that Barrie’s BDBN was witnessed by Mrs Munro and her other daughter Ms Moorecroft and unqualified persons prepared the documents

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Pensions

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PensionsDocumentation when an SMSF fails the minimum payment test for a pension?

Example:

• Jade’s pension is under the minimum 4% for FY2014

• TR 2013/5 states that the pension ceases

Queries:

• When does the pension cease?

• Do you need to document a roll‐back and the commencement of a new pension on 1‐7‐2014?

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PensionsExtracts from TR 2013/5 [with modification]:

18. A superannuation income stream [‘Pension’] ceases for income tax purposes if any of the requirements of the SISR 1994 relating to the payment of the [Pension] are not met in a financial year. This is the case even if a member remains entitled to receive a payment from the superannuation fund in relation to the purported [Pension] under the governing rules of the superannuation fund, or under general trust law concepts.

19. The trustee is taken not to have been paying a [Pension] at any time during the income year in which the requirements are not met.

20. If the requirements are again met in the following year this results in the commencement of a new [Pension].

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PensionsATO response:

It is strongly recommended that where a trustee is paying an income stream, appropriate documentation is maintained at all times. Where the regulatory rules such as meeting the minimum payment amount for a superannuation income stream were met in the following income year, a new pension would be taken to have commenced for the purposes of the regulatory and income tax law. At a minimum, the trustee would be required to have new documentation evidencing the revaluation of assets at market value and the recalculation of the minimum payment amount required under Clause 7 of Schedule 7 to the SISR. Additionally, the trustee would be required to have records reflecting the recalculation of the tax free and taxable components of the superannuation interest supporting the superannuation income stream.

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Pensions

Example:

• Jade’s pension is non‐reversionary

• Jade has a new spouse and wishes to make it automatically reversionary

Query:

• Can this be done without a roll‐back and the commencement of a new pension?

• Refer attached article ‘Making pensions reversionary mid stream’

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Disqualified trustees

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Disqualified trustees

Example (https://www.ato.gov.au/Super/Self‐managed‐super‐funds/In‐detail/SMSF‐resources/SMSF‐case‐studies/Case‐study‐‐‐disqualified‐trustees/): 

• Sally is a member/trustee of the ABC SMSF with two others trustees

• Sally has recently been convicted of an offence involving dishonesty

What should happen now?

• She must cease being or acting as an SMSF trustee immediately

• The remaining trustee’s must notify ATO of the change w/i 28 days

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Disqualified trustees

• The SMSF has 6 months to resolve the fund’s status and options include: 

• Transfer Sally’s super to another complying fund• Appoint an RSE licensee as trustee, ie, become a small APRA fund• Wind‐up the SMSF

• Because Sally was disqualified for being convicted of dishonest conduct, she can apply to us for a waiver if she wants to continue acting as a trustee. She doesn’t have to resign until we make our decision (and then only if we don’t give a waiver) if she applies within 14 days of her conviction. If we receive the request more than 14 days after the conviction, Sally must resign immediately.

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Disqualified trustees

• Sally will commit an offence if she continues to be or act as a trustee when she knows she is disqualified. Penalties including fines and imprisonment can apply

• Mourchad v FCT [2014] AATA 223 the ATO rejected a waiver well outside 14 days. Mr Mourchad sought a review at the AAT and was disallowed as the Tribunal was not satisfied that there were exceptional circumstances 

• DBA Lawyers have represented numerous disqualified persons. Refer attached article ‘SMSF trustees — disqualified due to dishonest conduct’

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AdminPenalties

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Admin penalties

Brief recap:

• Since 1‐7‐2014 the ATO have the following new powers:• Rectification directions

• Education directions

• Administrative penalties (‘AP’)

• The APs:• range from $850 to $10,200 per contravention

• apply to each individual trustee (only 1 x per Co trustee but directors pay)

• usually contraventions don’t occur as isolated incidents, eg, mum and dad trustees and 3 contarventions

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Admin penalties• Thus, mum and dad would be up for:

2 x $10,200 x 3 = $61,200 (jackpot!)• If they had of listened to your recommendation however and invested in a Co trustee:1 x $10,200 x 3 = $30,600 

SAVING = $30,600 APs are the nail in the coffin of individual trustees!

• What process the ATO will notify? Will we receive warning or just the speeding/parking (AP) ticket in the mail? 

• Will we be given a show cause opportunity?

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Admin penaltiesQ: The ATO’s findings should be 1st put to the taxpayer before the penalty notice issues

Administrative penalties are imposed by law as per s166 of the … SISA. The Commissioner has discretion to remit all or part of an imposed penalty.Where the ATO identifies a possible contravention (eg an auditor contravention report is lodged) that is considered low to medium risk the Commissioner does not consider that a penalty has been imposed. This is because the contravention has not been verified. In these cases the ATO will contact the trustee/s either by letter or by telephone, advising of reported contraventions and requesting trustee/s rectify if required.Where contraventions or funds are identified as high risk the ATO will raise an audit or review case to verify any contraventions. Penalties will only be considered to be imposed if contraventions are verified. In these cases the ATO is in contact with the trustee/s (or their advisor) and will discuss penalties and remission with them. Penalties and possible remission decisions are included in position papers and show cause letters, which provide the opportunity to provide information on further grounds for remission. There should be no instances of trustee/s being ‘hit up’ with penalties without notice.

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Abbreviations• FSI: Financial Systems Inquiry

• LPR: Legal personal representative

• LRBA: limited recourse borrowing arrangement

• NALI: non‐arm’s length income

• NCRP: non‐commercial related party 

• PBR: private binding ruling

• SISA: Superannuation Industry (Supervision) Act 1993 (Cth)

• SISR: Superannuation Industry (Supervision) Regulations 1994 (Cth)

• TASA: Tax Agents Services Act 2009 (Cth)

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Questions

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Level 1, 290 Coventry Street (PO Box 2085) South Melbourne Vic 3205 Ph: (03) 9092 9400 Fax: (03) 9092 9440 dba@dbalawyers.com.au www.dbalawyers.com.auDBA Lawyers Pty Ltd ACN 120 513 037

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Another BDBN fails due to poor SMSF documents Munro v Munro [2015] QSC 61 is the latest case involving a binding death benefit nomination (‘BDBN’) that was held not to be binding. This case is a very important decision as it confirms that BDBNs for self managed superannuation funds (‘SMSF’) can last indefinitely. The facts Mr Barrie Munro practised as a solicitor during his working life. He died in August 2011 at 66 years of age. He was survived by his second spouse Mrs Patricia Suzanne Munro (‘Suzie’) and his two daughters from his previous marriage, Ms Vanessa Munro and Ms Elke Munro-Stewart who were the Applicants in this case. The dispute was between Suzie and her daughter Ms Pooley as the Respondents and Mr Munro’s two daughters as Applicants regarding ‘The Barrie and Suzie Super Fund’ (‘Fund’). in February 2012, Suzie’s daughter, Ms Pooley, replaced Mr Munro as a co-trustee. Mr Munro signed a document entitled ‘Binding Death Benefit Nomination’ on 22 September 2009 (‘2009 BDBN’) to direct the Fund trustees to pay his death benefits on his death ‘to my estate’. Note that this error had also previously been repeated on 19 July 2004 in a non-binding nomination prepared by Mr Munro’s financial planner and on 25 May 2006 in a prior BDBN prepared by his accountants. The BDBN form noted a description of a ‘nominated beneficiary’ and that when you nominate your executor you should enter legal personal representative. This is described in paragraph 11 of the judgement as:

[11] On 22 September 2009 Mr Munro signed a printed form entitled “Binding death benefit nomination” that had his name and particulars written on the form, but in the section of the form that allowed for the specification of the nominated beneficiary, the name of the beneficiary had been typed in as “Trustee of Deceased Estate” and the percentage of benefit to be received was designated as “100%”. The relationship of the nominated beneficiary was shown as “Trustee”. The section of the form that contained the details of the nominated beneficiary contained this instruction:

“Each nominated beneficiary must be your spouse (legal or de facto), child (including adopted or step-children), financial dependant, interdependent or the executor of your estate (as stated in your will). When you nominate your executor you should enter legal personal representative in the relation column.” [Emphasis added.]

The Respondents considered the BDBN to be invalid and wanted to exercise their discretion in relation to the payment of Mr Munro’s death benefit. An interlocutory order was made on 11 February 2015 that restrained the Respondents from making any decision to distribute the death benefit other than to the Applicants. Did the BDBN have to comply with the SIS Regulations? This Munro judgement mainly deals with the validity of the 2009 BDBN. Mullins J at [35] to [36] stated:

[35] Although SMSFD 2008/3 is not binding on the court (or the Commissioner of Taxation) it sets

out a logical approach to the construction of s 59 of the SIS Act which I consider correct and

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adopt for the purpose of determining the applicability of reg 6.17A of the SIS Regulations to the fund.

[36] As s 59(1) of the SIS Act does not apply to a self managed superannuation fund, the exception to the application of s 59(1) found in s 59(1A) also does not apply to a self managed superannuation fund. Regulation 6.17A sets out the conditions for the purpose of s 59(1A) for the payment of a death benefit after the death of a member, but in view of the exclusion of a self managed superannuation fund from the operation of s 59(1), those conditions do not apply by virtue of either the SIS Act or the SIS Regulations to a self managed superannuation fund.

Mullins J distinguished the comments of Fryberg J in Donovan v Donovan [2009] QSC 26 which indicated in non-binding comments (ie, ‘obiter dictum’ compared to the binding reasons or ‘ratio decidendi’ of a judgement) that the SMSF deed in Donovan’s case imported the requirements of reg 6.17A of the SIS Regulations.

In Donovan’s case Fryberg J did not have to decide the issue of whether the criteria in reg 6.17A applied to an SMSF BDBN as the letter did not constitute a binding nomination but the judge did make the following non-binding comment:

… the letter did not manifest an intention to make a binding death benefit nomination …

In my judgment it is quite plain that the intent of the deed is to require the nomination to be in the form described in regulation 6.17A(6).

In contrast, in Munro’s case, it was noted that the definition of the ‘Statutory Requirements’ in the Donovan deed was broad and stated:

… means the requirements imposed under any law or by any Statutory Authority which must be satisfied by a superannuation fund in order to qualify for income tax concessions …

Again, Mullins J, distinguished Munro’s case form Donovan’s case, and noted the reason for this distinction as: [39] In contrast, the definition of “Relevant Requirements” for the purpose of the fund is

limited to any requirement the trustee of the fund or the subject trust deed must comply with in order to avoid a contravention of the requirements or in order for the fund to qualify for concessional taxation treatment as a complying super fund. The “Relevant Requirements” are defined as requirements only if they apply to the fund and therefore do not import reg 6.17A which does not apply to the fund.

This was an important point in coming to the decision that SMSFs are not subject to reg 6.17A. That is, in Donovan’s case, the ‘Statutory Requirements’ incorporated virtually all the requirements imposed under any law on superannuation funds (ie, incorporating by reference the criteria in reg 6.17A). In contrast, in Munro’s case, the ‘Relevant Requirements’ was limited to the requirements that the trustee must comply with in order to avoid any contravention or to qualify for tax concessions. The Munro definition therefore did not invoke any BDBN criteria in reg 6.17A. Thus, we now have Supreme Court authority (ie, the ‘ratio decidendi’ of a judgement rather than non-binding ‘obiter dictum’) confirming that if an appropriately worded SMSF deed is used, a BDBN for an SMSF can be non-lapsing and last indefinitely. This is consistent with the view DBA Lawyers’ have held for many years.

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Moreover, this outcome does away with a great deal of uncertainty that has existed to date as the cautious approach before this (Munro) decision, based on the obiter dictum in Donovan’s decision was that there was some risk in a non-lapsing BDBN (even assuming it was well worded SMSF deed) being overturned by a court given Fryberg J’s comments. Thus, it was recommended that while the better view was that an indefinite BDBN was the better view, it was still recommended to refresh them every three years as a safeguard. While the judgement is of a Queensland Supreme Court, it is likely to be persuasive and followed by Supreme Courts in other jurisdictions. Naturally, there could be other reasons why the Munro decision may not be applied in other jurisdictions, eg, if the wording in a particular SMSF deed can also be distinguished. Note that SMSF deeds are not a generic product and many SMSF deeds are unsatisfactory in this regard. SMSF deeds from many suppliers rely on a three year BDBN and many of these are easily challenged due to poor wording such as ‘the BDBN is only binding if it’s to the trustee’s satisfaction’. This type of wording can easily give rise to argument if say the trustee is the second spouse who says he or she does not like it when their spouse dies.

What did Mr Munro mean by nominating the ‘trustee of his deceased estate’?

The nomination of the ‘trustee of his deceased estate’ gave rise to a number of legal hurdles. Broadly, these included: Reg 6.22 of the SIS Regulations only allows a payment in favour of a dependant or

a member’s legal personal representative. The definition of legal personal representative in s 10 of the Superannuation Industry

(Supervision) Act 1993 (Cth) (‘SIS Act’) means, relevantly here, the executor of the will. The 2009 BDBN referred to the “Trustee of Deceased Estate”. An executor only becomes a

trustee after an estate has been administered and the Applicants argued that the BDBN did not need to comply with the criteria in reg 6.17A as that did not apply to an SMSF. This was noted at [32].

Thus, the Applicants had some hurdles to overcome for their arguments to succeed. The following extract highlights several of these hurdles. [32] … The applicants argue that the definition of Relevant Requirements in the trust deed

does not import reg 6.17A, but does import reg 6.22. Regulation 6.22 requires that the death benefit may be paid only to a legal personal representative or a dependant. The applicants argue the nomination dated 22 September 2009 made by Mr Munro in favour of the “Trustee of Deceased Estate” was intended to be operative as a binding death benefit nomination and should be given effect as such on the basis that “Trustee of Deceased Estate” is another way of referring either to the executors or, on an alternative argument, to the testamentary trustees as dependants.

The Respondents argued that reg 6.17A was imported into the Fund deed and argued other grounds in the alternative. Note that the 2009 BDBN that had been made by Mr Munro on 22 September 2009 was still well within a three year expiry period when he died in August 2011 (ie, the BDBN was around one month away from its two year anniversary). The Applicant’s argument that the BDBN did not have to comply with reg 6.17A was to seek ensure the BDBN would be valid. This is an interesting point as many disputes involving BDBNs, it is only the three year time period in reg 6.17A that is in dispute.

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The Munro decision highlights the need for a BDBN to follow the strict requirements of the particular SMSF deed. Mullins J analyses this as follows (extracting relevant paragraphs from the judgement): [45] Clause 31.2 regulates both the form and substance of the nomination. There is no

power given to the trustees under the trust deed or otherwise to dispense with compliance with the conditions set in clause 31.2 for a binding death benefit nomination. It is only a nomination for the purpose of clause 31.2, if all the conditions set out in that clause are met by the nomination. If it is intended to nominate the legal personal representative of the member who has since died, it must specify that it is nominating the legal personal representative or the executor of the will or name the executor of the will (if that coincides with the executor named in the last will), but identify that the named person is the legal personal representative.

[48] For the purpose of the SIS Act, the reference to “legal personal representative” has

the specific meaning of the executor of the will of the deceased person (where there is a will). Even if that definition did not apply, in the case of Mr Munro, the only meaning of legal personal representative must be to the executor of his will. Regulation 6.22 of the SIS Act Regulations is prescriptive as to when a member’s benefits can be cashed to persons other than the member and limit the circumstances in the case of the member’s death to the member’s legal personal representative and one or more of the member’s dependants. That is replicated by clause 31.2(b) of the trust deed for the fund.

[49] The form dated 22 September 2009 did not comply with either clause 31.2 of the

trust deed or reg 6.22 of the SIS Regulations, as the nomination was of neither Mr Munro’s executors under his will or one or more of his Nominated Dependants.

[50] The nomination form signed by Mr Munro on 22 September 2009 is therefore not a

binding nomination for the purpose of clause 31.2 of the trust deed. Conclusions The court ordered that the 2009 BDBN was not a binding nomination for the purpose of clause 31.2 of Fund deed (see [52]). The interlocutory injunction was also discharged. Thus, the death benefit could be paid out by exercise of the trustee’s discretion. As a matter of conjecture, Suzie and Ms Pooley, as the SMSF trustees, will most likely pay Suzie the death benefit in Mr Munro’s account in the Fund. It is interesting to also note that Mr Munro, who practised as a solicitor during his working life, did not pick up on the numerous legal issues in the documents provided by his accountant and financial planner. Advisers should ensure the documents they supply are reviewed and revised by a qualified, registered and experienced legal practitioner to ensure they do not become liable. As will be noted above, there were numerous issues that upset the BDBN in this case and the BDBN in question was supplied by an accountant. This judgement provides yet another reason why quality SMSF deeds and related documentation should be obtained as poor quality documents are likely to be ineffective. Ineffective documents can result in members having their super proceeds potentially paid to the wrong people; in many disputes, this is after expensive and lengthy legal battles. While some may seek to save a few dollars upfront using a cheap supplier, quality eventually wins out! Refer to the following for other related articles:

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http://www.dbalawyers.com.au/succession-planning/important-case-ever-smsf-succession-planning-really-means/

http://www.dbalawyers.com.au/smsf-deeds/wa-court-appeal-hands-appeal-decision-ioppolo-v-conti-implications-critical/

http://www.dbalawyers.com.au/smsf-deeds/smsf-succession-strategies/

http://www.dbalawyers.com.au/smsf-deeds/deficiency-many-smsf-deeds/

* * * This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. Note: DBA Lawyers hold SMSF CPD training at venues all around Australia and online. For more details or to register, visit www.dbanetwork.com.au or call Marie on 03 9092 9400.

Daniel Butler

27/3/2015

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Level 1, 290 Coventry Street (PO Box 2085) South Melbourne Vic 3205 Ph: (03) 9092 9400 Fax: (03) 9092 9440 dba@dbalawyers.com.au www.dbalawyers.com.au DBA Lawyers Pty Ltd ACN 120 513 037

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Making pensions reversionary ‘mid stream’

By Daniel Butler (dbutler@dbalawyers.com.au), Director DBA Lawyers Introduction

The ATO’s views in TR 2011/D3 highlight the importance of having appropriate documentation in place to ensure a pension is reversionary. Since the release of this draft ruling, reversionary pensions have become a hot planning issue. They allow a pension to continue to be paid to a surviving spouse retaining the pension exemption beyond the death of the pensioner resulting in greater tax efficiency. However, the question we analyse in this article is: can a pension that is commenced without a reversionary nomination, be readily ‘converted’ to a reversionary pension, without commuting the original pension and restarting a new pension which has a reversionary nomination? There is one school of thought that suggests this is not possible. However, most advisers believe there is no issue when the pension is in the nature of an account based pension such as an account-based pension, a transition to retirement income stream (‘TRIS’) or an allocated pension (that commenced prior to 20 September 2007). We will refer to these broadly as account based pensions for simplicity. This article seeks to clarify this point firstly by reference to account based pensions and will only cover defined benefit pensions (‘DBP’) such as lifetime, flexi and fixed term pensions that previously could have been commenced in SMSFs before 1 January 2006 for completeness. We note that due to specific legislative provisions, changing an existing non-reversionary DBP to be reversionary may give rise to certain issues. ATO’s most recent view What may have most recently given rise to the school of thought that suggests this is not possible was the ATO’s comments in the NTLG superannuation technical minutes of March 2010 where the ATO was asked a very different question to the question here. Namely, there, the ATO was asked: does a reversionary nomination in an account-based pension take precedence over a binding death benefit nomination (‘BDBN’) or are the trustees bound by the BDBN following the death of the original pension recipient? In addressing that question, the ATO remarked:

However, we would suggest that a pension that is a genuine reversionary pension, that is, one which under the terms and conditions established at the commencement of the pension reverts to a nominated (or determinable) beneficiary must be paid to the reversioner.

Although this remark was made in a very different context, it does seem to suggest that if a pension is not established as a reversionary pension at commencement, it can not be varied later to become a reversionary. Legislative analysis Naturally, the law should be examined. There is no express prohibition in the Superannuation Industry (Supervision) Regulations 1994 (Cth) (‘SISR’) nor in the Income Tax Assessment Act 1936 (Cth) (‘ITAA 1936) or Income Tax Assessment Act 1997 (Cth) (‘ITAA 1997’) that precludes a reversionary beneficiary being nominated after a pension has commenced. In particular, regulation 1.06(9A) of the SISR outlines the requirements for an account-based pension. Indeed, reg 1.06(9A)(c) allows a pension to be transferable to a beneficiary (including a reversionary beneficiary) on the member’s death. There is also no express preclusion in relation to the definition of a TRIS in reg 6.01(2) or in respect of an allocated pension in reg 1.06(4). Therefore,

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there is no express prohibition in the SISR or the ITAA 1936 or ITAA 1997 on a pension being made reversionary after a pension has commenced. Pensions — legacy rules Prior to July 2007, most people were generally reluctant to convert a pension to become a reversionary pension. Thus, most account based pensions prior to July 2007 were commenced as non-reversionary pensions. Reverting a pension could result in increased tax Prior to mid-2007, the ‘deductible amount’ which represented the old tax-free component of a superannuation pension payment was calculated in accordance with s 27H of the Income Tax Assessment Act 1936 (Cth) (‘ITAA 1936’). Broadly, this is calculated as the undeducted (now known as non-concessional) contributions used to purchase the pension, divided by the life expectancy of the beneficiary. Where a pension was reversionary, the longer life expectancy of the member or reversionary beneficiary had to be used: see TD 2006/72. As a result, the deductible amount calculated under ITAA 1936 s 27H would be decreased if the life expectancy used was increased. As such, it was generally undesirable to revert a pension to a surviving spouse prior to mid-2007 for this reason. In TD 2006/34 the ATO accepted that a change from a reversionary to a non-reversionary pension as a result of the marriage breakdown mid stream could occur but the deductible amount under s 27H needed to be adjusted accordingly. The ATO in paragraph 6 of TD 2006/34 state:

This is most likely to occur where the original pension was reversionary and subsequent to the marriage breakdown the pension ceases to be reversionary. Additionally, there is no other reversionary beneficiary and the pension will cease on the death of the member spouse. If the life expectancy of the member spouse is less than that used as the relevant number in the original calculation of the deductible amount then a different relevant number will need to be used in calculating the deductible amount of the new pensions.

Social security Broadly, assuming someone satisfies the assets test and other criteria, Centrelink’s income test assesses a member’s pension income less a deductible amount calculated on a similar basis to s 27H of the ITAA 1936. As such, if a member wanted to apply for Centrelink benefits such as the old age pension, it may be in their best interest to maximise their deductible amount in order to decrease the amount assessed under the income test. Therefore, making a pension reversionary ‘mid stream’ would typically decrease the member’s chance of being eligible for Centrelink benefits where the reversionary beneficiary has a longer life expectancy. Past practice It appears that the school of thought that ‘pensions must be commuted before being made reversionary’ also stems from the traditional or preferred approach practice above especially prior to July 2007. In summary, prior to July 2007 it was general practice to make an account based pension non-reversionary for tax and social security reasons and not to change them mid stream. Since mid-2007, the general practice has changed to commence pensions with a reversionary nomination unless this was not appropriate, eg, there is no surviving spouse. This is because since 1 July 2007 the tax free amount of a pension is generally determined according to the proportioning rule in s 307-125 of the ITAA 1997. This depends on the amount of

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the tax free component of the pension at commencement: s307-125(3)(a) of the ITAA 1997. This contrasts to the calculation of the ‘deductible amount’ for pre-July 2007 pensions under s 27H of the ITAA 1936 which depended on the longer life expectancy of the member or reversionary beneficiary. In summary, prior to July 2007, we understand that most account based pensions were non-reversionary. In contrast, from July 2007 onwards, we understand that most account based pensions are reversionary. Making an account based pension reversionary

Assuming there is flexibility in a fund’s governing rules and related documents (which may include deeds, resolutions, pension contracts and legislation, etc), there is no reason why the terms of a pension could not be varied after a pension commences (‘mid stream’) to add a reversionary pensioner. Indeed, this could, under an appropriately worded deed, be by way of a BDBN where a member specifies that their pension is to revert and continue to be paid to say their spouse upon and following their death. (We are aware and have covered in a prior article the debate relating to whether a BDBN wins out in the event of conflict against a reversionary pension nomination. Please contact us if you would like a copy of this article). Therefore, provided the documents provide the flexibility, a pension could be varied mid stream to nominate a reversionary pensioner. Defined Benefit Pensions For completeness, we will discuss the main reasons why DBPs should be treated differently in this context. Broadly, the commencement of new DBPs in an SMSF was prohibited after December 2005 and grandfather relief was provided to those DBPs that were commenced in an SMSF prior to 31 December 2005. Unlike ‘account based pensions’, a DBP requires an actuarial calculation to determine the annual pension payment. Broadly, the annual payment amount of a DBP is determined having regard to multiple factors including the amount of assets funding the pension, expected growth, mortality rates and whether the pension was reversionary or not. Whether a DBP is reversionary is a significant factor in this calculation — as with a given pool of funds, the longer the period of the pension, the lower the annual pension payment (assuming all other factors are equal). In essence, an SMSF trustee had to guarantee a member a certain sum each year, as indexed each year, for the remainder of the member’s life in respect of a lifetime DBP. Where the pension was reversionary, this guarantee was generally extended for the longer life expectancy. One of the requirements of a lifetime pension was that the size of payment of benefit in a year is fixed, allowing for variation only in limited circumstances (ie. in reg 1.06(2)(b), as specified in the governing rules). It was rare in practice to vary a DBP once commenced apart from exceptional circumstances. For example, after a marriage breakdown, or post-GFC, some SMSFs have had to vary payments due to insufficient liquidity. Moreover, a change to a term or condition of a DBP may be viewed by the ATO or Centrelink as creating a fresh pension which is no longer eligible for grandfathered DBP relief. See, for example, ATO SD 2004/1 and ID 2005/242 where the ATO outlined strict guidelines as to the requirements for DBPs. In particular, ATO ID 2005/159 examined whether an SMSF trustee could pay a DBP to a reversionary beneficiary under div 9.2B of the SISR. The ATO confirmed that the SMSF could, provided that the terms and conditions of the pension included the basis of the reversion when the original pension was established, and the original pension was established before or during the transitional period. These comments (in ATO ID 2005/159) should be considered in view of the special rules phasing out DBPs in SMSFs introduced before 2006.

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Conclusion

Being able to convert an existing account based pension to a reversionary pension is a key SMSF succession planning strategy. It can result in administrative efficiency, rather than having to commute an existing pension and then commence a fresh ‘reversionary’ pension. We note there is conflicting ATO views, albeit in different contexts as outlined above (ie, ATO TD 2006/34 in respect of s 27H of the ITAA 1936, the ATO’s views expressed in ATO ID 2005/159 in respect of reverting a DBP and the NTLG superannuation technical minutes of March 2010 in respect of BDBNs and reversionary pensions). We also understand that this matter is being reviewed by the ATO and Treasury in their broader finalisation of TR 2011/D3 and the treatment of pensions on the death of a member. There may be some legislative change that may soon be released to cover some of these issues and this area should therefore be closely monitored. The finalisation of TR 2011/D3 is also eagerly awaited. While we consider the law to be clear for allowing a reversion of an account based pensions mid stream, given the different ATO views, until greater clarity issues, the safer course would be to commute and start a fresh pension if a reversionary nomination of an existing non-reversionary pension is desired. However, for those who do not wish to go through the extra administrative hassle of commuting and starting a fresh ‘reversionary’ pension, they should either seek written comfort from the ATO or obtain further expert advice.

* * * * * * * This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. Note: DBA Lawyers hold SMSF CPD training at venues all around Australia and online. For more details or to register, visit www.dbanetwork.com.au or call Marie on 03 9092 9400. 17 October 2012

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Level 1, 290 Coventry Street (PO Box 2085) South Melbourne Vic 3205 Ph: (03) 9092 9400 Fax: (03) 9092 9440 dba@dbalawyers.com.au www.dbalawyers.com.au DBA Lawyers Pty Ltd ACN 120 513 037

SMSF trustees — disqualified due to dishonest conduct By Daniel Butler (dbutler@dbalawyers.com.au), Director DBA Lawyers

Many do not realise the extent of the disqualified person provisions in the Superannuation Industry (Supervision) Act 1993 (Cth) (‘SISA’). This can result in a person inadvertently acting as trustees of self managed superannuation funds (‘SMSF’) while disqualified. Doing so exposes these trustees to significant penalties. We explore some of the nuances of the disqualified person provisions and some practical steps to ensure advisers are aware of the risks and ensure their clients do not act as SMSF trustees while disqualified.

Certain persons disqualified from acting as trustees

The SISA prohibits certain ‘disqualified’ persons from acting as trustees of SMSFs. We consider an individual who has been convicted of an offence involving dishonest conduct and is therefore disqualified from being a trustee of an SMSF under s 120 of the SISA.

This prohibition also precludes such individuals from acting as directors of corporate trustees of SMSFs. For simplicity, I will simply refer to a trustee from now on which also includes a reference to a director of a corporate trustee.

What does ‘dishonest’ mean?

The term ‘dishonest’ is not defined in the SISA and therefore takes on its ordinary meaning. The Criminal Code Act 1995 (Cth) provides an interpretation, albeit in a different context, defining dishonesty by reference to the ‘standards of ordinary people’.

The courts have elaborated on this meaning in a number of criminal cases. In, R v Salvo [1980] VR 401) the word was generally found to be actions undertaken ‘discreditably, as being at variance with straightforward or honourable dealing’. In a different context, behaviour was considered to be dishonest ‘if it is done in the knowledge that it will produce adverse consequences for others’ (R v Bonollo [1981] VR 633).

In the cases relating to superannuation, there has been little commentary, other than a recognition that offences involving theft or deception for personal gain will almost inevitably be dishonest (refer to N2000867 v Australian Prudential Regulation Authority [2001] AATA 979; AAT Case 60/96 96 ATC 560; VBS v Commissioner of Taxation [2005] AATA 1303; VCA v Australian Prudential Regulation Authority [2008] AATA 580).

Shoplifting would clearly fall within the context of dishonest conduct. Indeed, the explanatory memorandum to the SISA in respect of s 120 includes an example that confirms someone convicted of a minor shoplifting offence some 20 years ago is disqualified.

However, there are obviously a whole range of offences that need to be considered that may fall within the realm of dishonest conduct and, if so, the person would be disqualified. The difficulty in practice is to determine whether some offences fall within the realm of dishonesty without undertaking considerable and in depth legal research; especially as some offences may fall within a grey or uncertain area.

EXAMPLE

An adviser is called by a concerned parent who asks whether her child who has just been caught on public transport without a valid ticket should do anything other than pay the $150 cost of the fine or fight it in court? The adviser then learns that this parent has only recently undertaken their estate planning on the basis that their two children would one day take control of the family SMSF following the death of their parents. If on close analysis of the legislation, the offence involved one where the child had intent to ride on public transport without a ticket, then that child may be forever precluded from becoming an SMSF member. On the other hand, the legislation may not require intent and therefore may not result in disqualification. However, this analysis on its own may give rise to a

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substantial legal cost to undertake hours and hours of research by an experienced lawyer costing thousands of dollars. Many parents therefore simply pay such fines without thinking any further.

Accordingly, advisers should be alert to the range of possible offences which may on their face not appear to disqualify a person but on a detailed analysis of the law may have the potential to result in disqualification. For instance, drug related offences may not necessarily result in disqualification but being a drug dealer is generally considered to be ‘discreditable, at variance with straightforward or honourable dealing’ per Salvo’s case above. Research into the nature and type of conviction may result in certain drug related offences leading to disqualification.

Interestingly, however, someone who commits murder is not disqualified.

As you will appreciate from this brief analysis, the law here is complex and extremely difficult to administer in practice. Indeed, this area of the law needs reforming in order to clarify what falls within the (disqualification) net. Advisers and SMSF trustees should not be put at risk by offences which are not within a prescribed ‘net’ of convictions.

Until the law is reformed, advisers, especially auditors have to be vigilant or potentially face liability for claims by disqualified persons who should not be SMSF trustees that get hit with penalties.

Penalties

There is a real risk of significant penalties for a disqualified person acting as a trustee of an SMSF. Section 126K of the SISA provides several penalties for a disqualified individual acting as trustee of an SMSF. Individuals who are or become a disqualified person and act as trustee of an SMSF face criminal and civil penalties of two years in prison or a $10,200 penalty. Further, trustees of SMSFs who become a disqualified person must immediately inform the ATO or face a penalty of $8,500.

Thus, a detailed investigation should not be deferred or swept under the carpet thinking the risk will simply fade away in time. This is also an offence involving strict liability (ie, no intention to contravene needs to be proved).

Past and overseas offences

In particular, the SISA extends the definition to anyone convicted at any time under a law of the Commonwealth, a State, a Territory, or a foreign country. As such, there is potential that no matter where a conviction was recorded, or when it was recorded (including before the SISA came into force in late 1992), the conviction will be relevant to determining whether the person is a disqualified person.

Spent convictions

Spent convictions are available under certain state, federal and overseas legislation that generally prohibit the disclosure of offences in some circumstances. In some cases, a conviction that is more than 10 years old may no longer require disclosure. However, the SISA expressly excludes the law on spent convictions, and accordingly, spent convictions are still relevant for determining whether a person is a disqualified. One tribunal decision involved an overseas equivalent of a spent conviction that was held to be covered by the SISA (see the discussion of AAT Case 60/96 below).

Case study — AAT Case 60/96

In AAT Case 60/96 96 ATC 560 the Administrative Appeals Tribunal affirmed the disqualification of a trustee who had been convicted and paid a monetary fine in the United Kingdom in 1969 due to fraudulent insurance claims. It was argued that the convictions were covered by the Rehabilitation of Offenders Act 1974 (UK) that operates in, broadly, a similar fashion to spent convictions.

The tribunal confirmed offences involving dishonest conduct committed prior to SISA and overseas were otherwise covered even though the offence was a spent conviction under UK legislation. This was despite the person being only 21 years old at the time, receiving minor punishment and having had an exemplary record over decades as a successful investment manager and chairman of managed funds.

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Waiver of status as a disqualified person

The SISA provides limited scope to apply for a waiver of disqualified person status. An application can be made to the ATO or the Federal Court. Different requirements apply to these applications. For example, very strict timeframes are placed on applications to the ATO and the offence can not be one of ‘serious’ dishonest conduct being one that can result in greater than two years imprisonment.

While the ATO may overlook certain minor offences it is unlikely to look favourably on anyone convicted of fraudulent social security/Centrelink, tax and similar claims.

The ability to apply to the Federal Court is less restrained though brings its own considerations as to cost and the likelihood of success.

Steps for advisers

We now consider some practical steps that advisers can take to ensure their clients are not caught out as many do not undertake routine checks on their clients’ background before establishing SMSFs for them.

Advisers should be alert to the above issues for both providing quality service as well as minimising any risk of providing inaccurate or negligent advice. Practical measures may include a ‘best practice’ checklist that compels trustees to consider these issues for each newly established SMSF. Ongoing compliance is also important such as an annual certification that the trustee has not been convicted of dishonest conduct. Advisers should also consider these issues in relation to estate and succession planning: have all proposed, current and future successor trustees, eg, spouse and children, been vetted to ensure they are not disqualified persons?

A police check can be undertaken to overcome a person’s possible oversight of a prior conviction that took place many years ago. Typically, a state and federal police check is required and if the person is from an overseas country with a similar process, an overseas police check could also be undertaken. Auditors particularly may like to obtain such clearances.

Finally, DBA Lawyers provide assistance in respect to a wide range of legal aspects to SMSFs. Further, we draft our SMSF documentation with the above in mind regularly prompting advisers and potential trustees to consider whether they may be a disqualified person.

* * * This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.

Note: DBA Lawyers hold SMSF CPD training at venues all around Australia and online. For more details or to register, visit www.dbanetwork.com.au or call Marie on 03 9092 9400.

27 October 2013

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