As we are about to enter a new financial year, attention turns to year end planning issues, such as; maximising superannuation contributions and ensuring the required level of pension is withdrawn, before year end.
However, there are other issues that could cause considerable grief if not properly considered by SMSF trustees, including non-arm's length income and binding death benefit nominations. We explore both in further detail below.
What is considered non-arm’s length income?
The concessional tax rates that apply to superannuation funds -15 per cent when a fund is in accumulation and zero per cent when a fund is in pension mode - may encourage fund trustees to artificially increase the income derived by a fund.
To discourage this type of behaviour, the Tax Act contains provisions to tax income derived by a fund at 47 per cent if:
- The trustee(s) entered a Scheme
- The parties involved were not dealing with each other at arm’s length
- The fund income is more than expected, or an expected expense is either not incurred or is less than expected.
SMSF trustees may impact the taxation of fund income if they carry out activities on behalf of the fund without charging an arm’s length fee.
LRC 2021/2 deals specifically with what happens when an expense is either not charged, or charged at a reduced rate, when the service was provided by an associate of the fund.
Take the example of a plumber with an SMSF that owns a rental property. Naturally, they would be inclined to attend to any plumbing issues affecting that property themselves.
However, LCR 2021/2 contains two examples that are difficult to reconcile. In the first example, the plumber stops by the rental property and replaces a water heater. The job is done quickly, the plumber’s staff is not involved, and the plumber does not need to use many of his tools. In this instance, the work carried out is considered minor and incidental by the ATO and is considered to be carried out by the plumber in their capacity as a trustee of the fund, as opposed to the plumber’s business.
As a result, the work carried out is not considered to trigger the non-arm’s length provisions and the rental income continues to be taxed at concessional rates.
In the second example, the plumber replaces the bathroom in a second rental property. This work is not considered by the ATO to be minor or incidental and because an arm’s length fee is not charged for the work, it is likely that the rental income from that property will be considered non-arm’s length income (NALI) and taxed at 47 per cent.
The problem for those managing their own SMSFs is: When does minor and incidental work become more significant, such that NALI provisions are triggered?
We recommend anyone personally carrying out work with respect to the management of their SMSF checks with their SMSF adviser to ensure they don’t inadvertently breach NALI provisions and trigger a much higher income tax rate for the fund income.
What is a Binding Death Benefit Nomination?
Above all else, members of an SMSF want their fund benefits to be paid to their preferred beneficiary in the event of their death.
An effective way to ensure this occurs is to complete a Binding Death Benefit Nomination (BDBN). When correctly completed, a BDBN instructs the fund trustee that the death benefit must be paid to a beneficiary in the way specified.
Under some SMSF trust deeds, BDBNs are non-lapsing and will continue to operate from completion until the death of the member. However, other deeds do not allow non-lapsing BDBNs and in many of these cases, the BDBN lapses three years after they are completed.
The difficulty that can arise is the fund member completes a lapsing BDBN, then loses mental capacity within the three-year period, and cannot execute a new BDBN. In this case, the trustee is now left without any direction by the member and is free to distribute the death benefit as it feels it should.
A decision by the Supreme Court of Queensland (Re Narumon Pty Ltd (2018) QSC185) considered whether a person that holds Enduring Power of Attorney (EPOA) was able to renew a BDBN where the original nomination has lapsed, and the member has lost mental capacity.
The Court held that:
- There does not appear to be any restriction in the Superannuation legislation that would prevent a person that holds an EPOA from extending a BDBN for the person for whom they are acting as Attorney.
- In this case, there was nothing in the SMSF deed that would prevent an Attorney from extending the BDBN, however, this would need to be checked in every instance.
- Therefore, the question of whether a BDBN could be extended under an EPOA would be dependent on the Power of Attorney Act in each state.
The issue of lapsing BDBNs can throw a person’s estate plan into disarray. However, Narumon’s case does provide a pathway, whereby a fund member’s BDBN can be extended in some circumstances.
If issues relating to non-arm's length income or binding death benefit nominations potentially apply to members of your fund, please speak to one of our dedicated Superannuation advisers.