SMSF TechnicalSuperannuation dependents under tax and super law - Grow SMSF

July 26, 2020by Grow SMSF

The definition of a superannuation dependent under the Superannuation Industry (Supervision) Act 1993 (SIS) is different to the definition under the Income Tax Assessment Act 1997 (ITAA).

Why is the meaning of dependant for super and tax purposes important?

The meaning of dependant is particularly important in relation to the payment and tax treatment of superannuation death benefits.

There are different requirements for each of the following purposes:

  • eligibility to receive a member’s death benefits directly from a super fund (subject to the fund’s governing rules)
  • eligibility to receive a member’s death benefits in pension form (subject to the fund’s governing rules)
  • the availability of the death benefit dependant tax concessions, and

Tax treatment of super death benefits – tax dependant

Benefits paid to beneficiaries who are dependants for tax purposes are generally taxed more favourably compared to benefits paid to non-dependants.

A dependant for tax purposes (tax dependant) is defined differently to SIS dependant.

A tax dependant includes:

  • an individual’s spouse
  • an individual’s former spouse (if any)
  • an individual’s child under the age of 18, and
  • someone with whom the individual has an interdependency relationship.

Like a SIS dependant, a tax dependant also includes an ‘ordinary meaning’ dependant.

In addition, tax law provides that if the deceased died in the line of duty as either a member of the defence force or a police officer, beneficiaries of a super death benefit who are not tax dependants will be treated as tax dependants.

Taxation of superannuation death benefits

Any benefits made up of the tax free component are not taxable to the beneficiary regardless of whether they are superannuation dependents or not under the tax law definition.

Taxable components will be taxed at 15% plus Medicare Levy (2%) when received by a non-dependent under the tax act.

The following table summarises the tax applicable:

taxation of superannuation death benefits

*Medicare Levy = 2%

Taxation of superannuation death benefits paid to an estate

When a deceased members legal personal representative (estate) receives a superannuation lump sum which includes a taxable component and subsequently pays it to a non-tax dependent, the Medicare Levy is NOT payable.

The executor or the administrator of the estate must deduct tax from the taxable component of the lump sum before paying the death benefit to a non-tax dependant beneficiary.

The beneficiary does not need to declare this income in their tax return, hence no increase in their assessable and taxable income and non Medicare Levy payable on the superannuation death benefit.

What is the difference between a SIS dependant and a tax dependant?

The key differences between the two definitions are

  • a tax dependant does not specifically include an adult child (whereas a SIS dependant does)
  • a tax dependant specifically includes a former spouse (whereas a SIS dependant does not).

These differences mean that an adult child, while being eligible to receive a death benefit directly from a super fund (subject to the fund’s governing rules), will not receive the more favourable tax treatment that a tax dependant would receive unless they qualify under an ‘interdependency relationship’ or ‘ordinary meaning’ dependency.

In addition, the former spouse of a member is generally not eligible to receive a death benefit directly from a super fund (unless they qualify under an ‘interdependency relationship’ or ‘ordinary meaning’ dependency).

However, if they receive the benefit via the deceased’s estate, the estate will be eligible for the more favourable tax treatment.

Spouse

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

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, with one exception, 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.

The exception referred to occurs when the child has been receiving an income stream from the death benefits of a deceased member and, upon reaching 25 years at the latest, the benefit is paid as a lump sum to the child as required under the SIS legislation. That benefit will be paid tax-free.

Interdependency Relationship

An interdependency relationship exists between two people when they have a close personal relationship and:

  • they live together; and
  • one or each of them provides the other with financial support, domestic support and personal care.

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

Financial Dependency

Financial dependency is not defined in ITAA 97. The ATO, in an Interpretative Decision ID 2002/731 (although now withdrawn), 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.

Whilst the ATO will look for ‘substantial’ financial support, the Superannuation Complaints Tribunal has taken 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 that 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.

Minor payments, such as the payment of school fees for grandchildren, are unlikely to make those children financial dependants of the fund member.