Can an SMSF claim a deduction for future liability to pay death benefits?

There is a deduction available under s 295-470 of the Income Tax Assessment Act 1997 (Cth). It is called a deduction for future liability to pay death benefits.

Sometimes this deduction is thought of as an accompanying deduction along with s 295-485 anti-detriment deductions. However, a s 295-470 deduction for future liability to pay death benefits has never received as much attention as a s 295-485 anti-detriment deductions.

The ATO have recently released ATO interpretative decision ATO ID 2015/17 considering this deduction. I want to consider in this article how feasible it is for an SMSF to claim such a deduction.

Overview of the deduction

At the risk of sounding like a boring lawyer (as Popeye would say ‘I Yam What I Yam‘) I think the best place to start is the text of provision allowing the deduction.

1. A *complying superannuation fund can deduct an amount under this section for an income year if:
   1. the trustee of the fund makes a choice under subsection 295 465(4) and the choice applies to the income year; and
   2. the trustee pays:
      (i) a [death benefit, terminal medical condition benefit or a permanent disability benefit] for the income year in consequence of the termination of a member’s employment; or
      (ii) a [temporary incapacity] benefit … .
2. The amount the fund can deduct is:
   Benefit amount x [Future service days] / [Total service days]

In order to claim such a deduction, in addition to satisfying the above, at the risk of oversimplifying, the trustee must also choose to never again claim deductions for any insurance premiums. (See s 295-465(4) of the Income Tax Assessment Act 1997 (Cth).)

Insights regarding this deduction have been provided by ATO interpretative decision ATO ID 2015/17.

ATO ID 2015/17

In ATO ID 2015/17 the ATO consider whether a trustee of a complying superannuation fund may make the choice under s 295-465(4) to claim a deduction for future liability to pay death benefits under s 295-470, after the death of an insured fund member.

The ATO answer is in the affirmative.

On its face this sounds very positive as it gives more flexibility to funds to claim this deduction.

However, in my experience, this deduction is riddled with problems and it is very difficult to ever successful claim such a deduction.

Some key problems are as follows.

Problems with the deduction

Problem 1 — SMSF must have been claiming insurance premiums

There is no express legislative requirement that the fund must have been claiming insurance premiums in order to be able to claim a deduction for future liability to pay benefits. However, based on private ruling 17434, 72302 and more, it is a fair inference that the Commissioner will require this to occur in order to allow such a deduction.

Statistically, few funds have insurance policies. The Cooper report suggested it was slightly less than 13%. Accordingly, most fund are probably ineligible on this ground alone.

Problem 2 — ‘in consequence of’

The death, terminal medical condition or permanent disability benefits must be paid ‘in consequence of the termination of a member’s employment’. This is a fairly strict test.

The Commissioner takes the view that (Taxation Ruling TR 2003/13 [5]):

… a payment is made in respect of a taxpayer in consequence of the termination of the employment of the taxpayer if the payment ‘follows as an effect or result of’ the termination. In other words, but for the termination of employment, the payment would not have been made to the taxpayer.

The test adopted by the Commissioner means the common situations regarding death will not be captured. Consider the following example from the ruling:

Sarah Martin retired from her job as a machinist because she had a long-term illness. Upon retirement, Sarah became entitled to, and was paid a disability pension from her superannuation fund. The governing rules of the superannuation fund permitted a pension recipient to commute all or part of the pension into a lump sum at any time from the date of retirement. Six months after retirement Sarah elected to commute all of her pension and was paid a lump sum (the first commutation payment). Sarah used the lump sum to purchase an allocated pension. Three years later, Sarah commuted the allocated pension and was once again paid a lump sum (the second commutation payment). Sarah then purchased another allocated pension.

The first commutation payment would be taken to be [a lump sum] that was paid in consequence of the termination of employment by reason of incapacity. But for the termination Sarah would not have been entitled to the disability pension. The right to commute the pension existed at the time of termination. Therefore the termination, the right to commute and the payment are interwoven. The requisite causal connection between the termination and the payment is present.

The second commutation payment would not be taken to be [a lump sum] that has been paid in consequence of the termination of employment by reason of incapacity. Although it could be concluded that, but for, the termination the second commuted payment would not be made, the causal nexus between the termination and the payment is too remote for a conclusion that the payment was made in consequence of the termination of employment. The purchase of the first allocated pension is an intervening event which severed the connection between the termination and subsequent events. Put another way, the purchase of the first allocated pension and the resulting commutation payment are not interwoven with the termination, and do not form part of the same occasion.

Accordingly, consider the following example.

Caroline is diagnosed with cancer and ceases employment. The trustee of an SMSF receives an insurance pay out in respect of this. Several years later Caroline dies. Death is a compulsory cashing event. Accordingly, the trustee of the SMSF pays out her benefits as soon as practicable. In light of Taxation Ruling TR 2003/13 the Commissioner seems to be unlikely to view these death benefits as being in consequence of Caroline termination of employment. Accordingly, the Commissioner seems to be unlikely to allow the SMSF trustee to claim a deduction for future liability to pay benefits.

For completeness, it must be noted that Taxation Ruling TR 2003/13 was released in a slightly different context. Nevertheless, it still provides relevant insights.

Problem 3 — cuts out at age 65

Generally, when a member reaches age 65, there is no availability of deductions for future liability to pay benefits. This can be contrasted with anti-detriment deductions, for which there is no age limit.

Conclusion

On paper, deductions for future liability to pay death benefits sound great (particularly in light of ATO ID 2015/17). However, in practice they have many problems and the odds of having an SMSF that can validly claim such a deduction are very low.

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