Superannuation and skirting the shoals of bankruptcy **

The Federal Court's decision in Cunningham (Trustee) v Gapes (Bankrupt) [2017] FCA 787 (Federal Court, Collier J, 13 July 2017) (Cunningham) is vital guidance for all advisers in relation to the interplay between superannuation death benefits and the Bankruptcy Act 1966.

In particular, the case highlights the fact that a superannuation death benefit paid via a deceased estate to a bankrupt beneficiary is divisible amongst the creditors of the bankrupt.

At a minimum therefore, advisers should consider advising clients who have at risk potential beneficiaries to utilise a binding death benefit nomination (BDBN). The BDBN should mandate that any death benefit is paid directly from the superannuation fund to a beneficiary at risk of bankruptcy, ideally as a lump sum (given that a pension stream will be subject to the threshold income limits).

Testamentary trusts

One additional strategy that should be considered in the context of deceased estates generally, and specifically in relation to superannuation death benefits, is the use of comprehensive testamentary trusts.

As readers will be aware, 1 of the key reasons that testamentary trusts are often recommended is due to the asset protection offered by the structure generally, and in particular where a potential beneficiary is at risk of suffering an event of bankruptcy.

This approach can help protect beneficiaries, regardless of whether a BDBN is in place, or where a BDBN is implemented and mandates payment of the death benefits to the legal personal representative for distribution under the will.

Importantly, testamentary trusts also provide significant flexibility from a tax planning perspective, as compared to the benefits being paid directly to the bankrupt beneficiary. Previous posts have explored a number of the tax planning issues in relation to testamentary trusts (see for example our posts on 13 May 2014 and 27 October 2015).

Unfortunately, we have seen a number of examples recently where no testamentary trust has been incorporated under a will, with superannuation death benefits passing directly to the estate and then in turn to a bankrupt beneficiary. In other words, creating the exact same factual matrix as existed in Cunningham.

Key issues to remember

In summary, the key issues to be aware of in this type of situation are as follows:

1. Where a beneficiary is bankrupt at the time of the death of the willmaker, the bankruptcy legislation mandates that the bankrupt's entitlements are to pass to their trustee in bankruptcy.
2. If there are any assets remaining after the bankruptcy has been discharged, then the beneficiary is entitled to those assets.
3. The right to due and proper administration of the deceased estate is an asset that forms part of the bankrupt's estate, and therefore also vests in the trustee in bankruptcy.
4. If an executor of an estate seeks to avoid assets passing to a trustee in bankruptcy where a beneficiary is entitled personally under the will, the executor will themselves be personally liable.

Importantly, each of the above issues can be legitimately avoided by the appropriate structuring of a testamentary trust into a will, prior to death.

Where testamentary trusts are not included under a will, best practice dictates that the executor should obtain a formal declaration from each beneficiary, before making distributions to them under the will, whereby each beneficiary confirms that they are in fact solvent.

If a beneficiary refuses to provide the declaration, then further searches should be made by the executor to minimise the prospect that the executor might become personally liable to a trustee in bankruptcy.

As usual, if you would like copies of any of the cases mentioned in this post please contact me.

The above post is based on the article we had published originally in the Weekly Tax Bulletin.

** For trainspotters, ‘skirting the shoals of bankruptcy’ is a line from a song named ‘Accountancy Shanty’ by Monty Python from their 1983 movie ‘The Meaning of Life’.

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How soon is now ** (or ‘as soon as practicable’)?

Last week’s post considered the phrase ‘as soon as practicable’ in light of the 2017 superannuation changes.

Regulation 6.21 of the Superannuation Industry (Supervision) Regulations 1994 (Cth) requires death benefits to be cashed ‘as soon as practicable’ following the death of a member.

Unfortunately, ‘as soon as practicable’ is not defined in the Regulations and has not been otherwise defined.

Generally in our experience the Tax Office has historically expected death benefits to be paid within 6 months of a person's death, or earlier if possible.

While perhaps not directly relevant, part of the reason for this approach is likely to be because under section 17A(4) of the Superannuation Industry (Supervision) Act 1993 (Cth), any replacement trustee (or replacement director of a corporate trustee) must resign within 6 months of the death benefits commencing to be paid. In other words, 6 months is legislated in a manner that is arguably analogous to the concept of ‘as soon as practicable’.

This said, if there are objectively reasonable circumstances preventing payment for more than 6 months, this is unlikely to cause a breach of the rules, so long as the payment occurs as soon as practicable once the relevant circumstances have been resolved.

Some examples of where a payment after 6 months may still meet the ‘as soon as practicable’ test include -

1. It may be that probate of a member's estate is seen as required before paying a death benefit, and generally probate will take longer than 6 months;
2. If there is a risk that an estate may be challenged or the potential recipients of a death benefit challenging the trustee's decision, confirming that the risk has passed will generally take longer than 6 months;
3. Similarly, if there is an actual challenge to a deceased estate this may warrant delaying paying of a death benefit;
4. If there is uncertainty about the validity of any purported binding death benefit nomination this may take longer than 6 months to resolve;
5. The nature of the assets in a fund may make distributions within 6 months impossible, for example illiquid assets such as real estate or investments in platforms that have large penalties for early withdrawal;
6. It may also be that the values of assets that are will form part of the cashing take an extended period to value;
7. Surrounding circumstances, such as poor health of a surviving fund member may also justify a payment commencing later than 6 months.

Interestingly, the 2017 superannuation reform legislation permits a reversionary beneficiary 12 months to decide if they wish to cash their benefit before it is automatically credited to their transfer balance. This allowance may (again by analogy) support the argument that a death benefits payment within 12 months will meet the ‘as soon as practicable’ test, even without other explanatory reasons.

As usual, please make contact if you would like access to any of the content mentioned in this post.

** for the trainspotters – check out iconic 1980s new wave band The Smiths perform ‘How soon is now?’.

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Walking the line** - understanding what does ‘cashed' means

Last week’s post focused on the issue surrounding ensuring an SMSF maintains compliance following the death of a member.

One issue raised following that post related to how the superannuation rules work in the context of the requirement that a member’s benefits must be ‘cashed as soon as practicable’ after the death of a member, which is set out under the Superannuation Industry (Supervision) Regulations at regulation 6.21(1).

In particular, the question is whether a death benefit can be simply transferred to a surviving member’s account by way of journal entry.

In this regard, in most other areas of the law, where two parties owe mutual liabilities or obligations, they can be set off the liabilities against each other through a book entry (see our earlier post in relation to Spargo case).

The Tax Office has confirmed that the principle in Spargo’s case can also apply to SMSFs where there are mutual liabilities between the relevant fund and another party (see ATO ID 2015/2).

The Tax Office has confirmed in ATO ID 2015/3 however that a death benefit cannot be satisfied simply by way of journal entry, as death benefit dependants do not owe anything to the fund, that is there is no mutual liability to set off against the SMSF.

Therefore, death benefits must actually be paid to the death benefit dependant by the transfer of ownership of assets out of the SMSF.

The Tax Office also confirms that the Superannuation Industry (Supervision) Regulations do not allow for payments to be made to members by way of journal entry.

In particular, regulation 6.17(2) requires payments to be transferred out of the SMSF.

Unfortunately, this requirement for formal payment can in a practical sense trigger unnecessary transaction costs as well as complicating and delaying the death benefit payment process.

As usual, please contact me if you would like access to any of the content mentioned in this post.

** For the trainspotters, the title of today's post is riffed from the Johnny Cash song 'I walk the line'.

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The fine line (& time)** between being entitled … and not

An often over looked aspect of estate planning related to the payment of death benefits from a superannuation fund.

While with a gift under a will a beneficiary who dies after the willmaker, but before the distribution is made, will still (through their own estate) be entitled, this generally is not the case with superannuation benefits.

Arguably the leading case in this area is Webb v Teeling [2009] FCA 1094.

In summary the factual scenario was as follows -

1. a member of a super fund had passed away, validly nominating a dependant to receive the death benefit;
2. the dependant was alive at the time of the member’s death;
3. the dependant however subsequently died before the death benefit was paid and their legal personal representative (LPR) sort payment to the originally nominated beneficiary's estate.

It was held that the death benefit could not be paid to the LPR of the deceased dependant because they were neither:

1. a dependant of the deceased member; or
2. the deceased member’s LPR.

With the aid of hindsight, the workaround in similar situations is to ensure that if the nominated beneficiary dies before the death benefit is paid, the funds should pass (ideally under a binding nomination) to the LPR of the member.

The member's will should then direct the amount specifically to the intended recipients and can do so without restriction as the superannuation rules will have been complied with by the initial payment to the member's LPR.

As usual, please contact me if you would like access to any of the content mentioned in this post.

** for the trainspotters, ‘Fine Time’ is a song from New Order.

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