Who is a superannuation dependant under taxation law? (part 2 of 2)

The first paper in this series considered the range of individuals who may be entitled to receive a superannuation death benefit. This paper, the second of two parts, considers those who would be classified as superannuation dependants under taxation law.

The SIS Act tells a trustee to whom a death benefit may be paid. The Tax Act tells the trustee how that benefit is to be taxed.

Differing taxation implications apply to individuals entitled to receive superannuation death benefits following the passing of a member and the disbursement of their superannuation death benefits.

Definition of ‘tax dependant’

A ‘death benefits dependant’ is defined in the Income Tax Assessment Act 1997 (ITAA 97) as:

• Spouse or former spouse¹;
• Child, aged less than 18 years;
• 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.

Superannuation Dependents

The Superannuation Industry (Supervision) Act 1993 (‘SIS Act’) lists three main categories of persons who may be classified as a dependant of a deceased member (‘SIS dependant’)².

It can be noted that the tax definition of dependant differs to some extent from the SIS definition.

Spouse

The tax definition is the same as the SIS definition, with the addition of ‘former spouse’.

It should be noted a trustee cannot pay a death benefit to a former spouse simply because they are a former spouse.

However, if the former spouse meets a definition of dependant under SIS legislation, such as financial dependency, any payment made by the trustee to that former spouse would be treated as a payment to a spouse for tax purposes.

Child

The tax definition of child is the same as the SIS definition, except for a distinction between minor children and those over 18 years of age.

Under the tax definition, a child is considered to be a dependant of the deceased only if he or she is under age 18.

If the child is over 18 years of age, he or she would need to meet one of the other definitions of tax dependant, such as financial dependency or interdependency, to be treated as a dependant for tax purposes.

This means that a trustee is able to pay a death benefit to a child of the deceased who is over 18 years of age, but the payment will be treated as a death benefit payment to a non-dependant for tax purposes, unless that child meets the tax definitions for financial dependency or interdependency.

Interdependency Relationship

The tax definition of an interdependency relationship is the same as the SIS definition.

Financial Dependency

Whilst ‘Financial dependency’ is not defined in ITAA 97, the ATO, in a paper titled ‘Super death benefits’ (QC 37785), provides a summary of the ATO's view of financial dependency, to be considered when determining whether a person was financially dependent on a deceased member of a superannuation fund.

Although the ATO will look for ‘substantial’ financial support, the former Superannuation Complaints Tribunal took a broader view of what constitutes financial dependency, when applying provisions of the SIS Act.

Therefore, in rare cases, it may be that a trustee could determine a person was financially dependent on the deceased under the SIS definition, but not a dependant under the tax definition.

In other words, the trustee would be able to pay a death benefit to such a person, but the benefit may be taxed as a payment to a non-dependant for tax purposes.

Test as to actual relationship occurs at date of death of deceased member

As with the definitions under the SIS Act, the test to determine if the relevant individuals meet the tax definition of dependant will be applied at the time of the death of the member.

Tax on superannuation death benefit lump sums

A superannuation death benefit paid to a tax dependant will not incur tax.

For a beneficiary who is not a tax dependant:

• the tax-free component of a superannuation death benefit will be tax free in the hands of the beneficiary; and
• the taxable component will be subject to tax at the rate of 15%, plus Medicare levy.

The SMSF trustee will need to withhold the tax from the payment.

If the death benefit is paid to the estate of the deceased member, the SMSF trustee will not be required to withhold tax, but the Legal Personal Representative may need to account for tax on benefits paid, depending on whether or not the eventual beneficiaries are tax dependents.

Conclusion

For trustees attending to the payment of death benefits from an SMSF, the first consideration is to determine who may or may not be classified as a SIS dependant as, generally, superannuation death benefits may only be paid to SIS dependents or the Legal Personal Representative of the deceased.

The issue of taxation of the benefits paid to recipients of the deceased's superannuation death benefit then needs to be considered.

For members and advisers involved in planning for the eventual passing of a member, both the SIS definition and the tax definition of dependant should be taken into account as a vital component of the planning process.

It is important for trustees of SMSFs, and their advisers, to not only understand the range of individuals who may be entitled to receive superannuation death benefits, but the tax consequences in paying benefits to dependants of the deceased member.

Notes:

¹ Spouse includes de facto and same sex spouses.

² The SIS Act tells a trustee to whom a death benefit may be paid, the Tax Act tells the trustee how that benefit is to be taxed.

Differing taxation implications to individuals entitled to receive superannuation death benefits following the passing of a member and the disbursement of their superannuation death benefits.

Author: Class

For more information contact: Gavin.LeungShing@class.com.au