Back in 1988, the Government introduced the 15% tax on super contributions and reduced the tax on benefits from 30% to 15%. They asserted that by doing this, they were not increasing tax, but rather bringing forward the tax that would have otherwise been paid on benefits. However, since lump sum death benefits paid to dependants were not taxed at that time, bringing forward the tax was effectively increasing the tax on these benefits.
Compensation
To compensate for the contributions tax, a provision of the tax act was introduced to allow super funds to claim a deduction based on the increased amount of the lump sum death benefit that was paid to a spouse, former spouse or child of the deceased. This anti-detriment provision made the lump sum payment equal to the amount that would have been paid if no tax was payable.
In simple terms, this means that any lump sum death benefit paid to a dependant under the anti-detriment provision is increased to effectively refund the amount of contributions tax already paid.
Also taken into account are the earnings that would have accrued on the amount of tax paid on those contributions. The super fund could then claim a deduction based on the increased amount of the benefit. These provisions are now contained in section 295-485 of the Income Tax Assessment Act 1997 (ITAA 97).
There are two methods that can be used to calculate the tax saving amount: the audit method or formula method. The formula method is used by the ATO in interpretative decisions and is most often used.
The benefits
The anti-detriment amount provides a welcome boost to the death benefit payment paid to beneficiaries.
The deduction claimed by the super fund may bring a substantial benefit to the remaining fund members. It can be used to reduce the tax payable in the current year or if a tax loss arises in the super fund, the loss can then be carried forward to future income years.
Why wouldn’t everyone do this?
While the idea sounds great, there are certain reasons why it may not be appropriate for all lump sum death benefits.
Firstly, the fund’s trust deed must allow for anti-detriment payments before allowing the trustee to pay it out the fund.
Secondly, cash flow must be considered. The anti-detriment payment must be made in full in addition to the lump sum death benefit. This payment must be made before the super fund can claim the associated tax deduction. The fund must therefore have the ability to pay the additional amount without relying on the deduction.
Importantly for SMSFs, there must be a source from which to make the anti-detriment payment. It cannot be drawn from another member’s account, and therefore there must be an anti-detriment reserve established well in advance to accumulate to the amount of the required payment. This is not always done in SMSFs.
Alternatively, the payment may be made from life insurance policies that are allocated to a new reserve for these purposes. Again this must be detailed in the trust deed.
Also, if the member implements a re-contribution strategy, the anti-detriment payment is diluted or eliminated in some cases. This is because, under this strategy, benefits are withdrawn from the superfund when a condition of release is met, and then re-contributed to the fund as a non-concessional contribution. The amount re-contributed will no longer attract concessional contributions tax, and therefore there is no tax refund applicable to anti-detriment payments.
Finally, unless the super fund can make use of the deduction, the strategy is not beneficial. This is because anti-detriment payments apply to lump sum death benefits only. If the death benefit is to be paid as a pension, including a reversionary pension, the anti-detriment does not apply.
Pension phase limitations
Further, if the remaining members are wholly in pension phase, the income of the fund is tax exempt and any gains or losses are disregarded. Therefore the deduction to the super fund from the anti-detriment payment cannot be used unless a pension account is commuted back to accumulation phase or another accumulation account is created.
If the fund is wound up after the member’s death, this would also prevent the use of the deduction and nullify the strategy.
Food for thought
As we await legislation on the increased contributions tax for individuals with income greater than $300,000, it will be interesting to see how this will affect anti-detriment calculations. If an individual’s income subjects their super fund to 30% contributions tax in some years, and 15% in others, the calculation for the anti-detriment payments will need to consider the different contribution tax levels in order to correctly identify the increased amount of the death benefit.
This may cause additional administration burdens on super funds in record keeping and subsequent computation of the anti-detriment amount. We eagerly await the outcome.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should consider the appropriateness of the information in regards to their objectives, financial situation and needs and, if necessary, seek advice.
