Division 296 Final Regulations: Unresolved SMSF Issues | Heffron

The final Division 296 regulations provide some final clarity on a number of important issues for SMSFs – including how earnings are calculated when someone dies, how defined benefit interests are valued and how reserves are managed. But unfortunately they don’t include all the changes I would have liked made to the original draft.

Let me flag something up front that when it comes to Division 296 : overall I’m so pleased the Government ditched plans to tax unrealised capital gains that nothing else matters. But even so, there are still some elements of the final regulations released last week that are… annoying.

I’ll limit myself to three.

Calculation of earnings after death

Sadly, the Government hasn’t dropped its controversial idea of continuing to build up earnings for deceased members (so an even larger bill can be sent to their estate). I understand the theory – it means cases where large death benefits hang around in an SMSF for years will still give the Government Division 296 tax revenue. And it negates the strategy SMSFs might have adopted of deliberately waiting until the year after death to sell assets.

This strategy would otherwise be attractive. A deceased person’s total super balance is set to $nil on death, so they can’t have a balance over $3m at either the start or end of the year in the year after they die (ie they won’t be liable for Div 296 tax). Without the special extra rules included in these regulations, their fund could potentially realise very large capital gains in the year after death without anyone paying Division 296 tax on them. Unfortunately the regulations provide that the Government will keep a tally of all earnings after death until the benefit is actually paid out or used to provide a pension for someone else (such as the surviving spouse). The meter might continue running for years – with ever increasing earnings amounts being added back into the Division 296 assessment for the year of death.

Sound cumbersome? Absolutely – I respect the reason for the measure but I honestly think this is one time the Government could have sacrificed purity for simplicity.

It will have some obvious consequences:

• Those managing estates with outstanding SMSF death benefits will have to wait until the entire death benefit is paid out before the full extent of the Division 296 tax bill is known. And this will be true even if the estate isn’t actually getting the death benefit.
• Where the estate isn’t getting the super death benefit, we can expect disputes. Imagine, for example, the new spouse gets the super and is also the trustee of the SMSF but children from a previous marriage get the other estate assets. Delays by the spouse in dealing with the super will have a direct cost impact on the children she may not like very much.
  
  

Defined benefits

Not many SMSFs provide defined benefits but some defined benefit pensions remain. These have special rules for Division 296 tax – we touched on them here : Division 296 & Defined Benefits: What the New Rules Mean | Heffron

The final regulations set out the detail on how earnings and total super balance values are worked out for those funds. 

Broadly speaking they require SMSFs to use the rules and factors in the Family Law Act to place a value on the pension. I’d hoped they might also provide some simple guidance for funds that have pensions which don’t line up to any of the Family Law Act factors. For example, they might be indexed in ways not envisaged by the Family Law Act.

Unfortunately the Regulations don’t include the simple solutions I was looking for.

Reserves

The regulations have some sensible changes (compared to the first draft) for funds that hold pension reserves (ie, money supporting a defined benefit pension or an account that used to do so).  

In particular, the new formula for actuarial calculations to split up earnings between different member accounts works as follows:

(* pension reserves are reserves that are currently – or were in the past – used exclusively to support a pension.)

Previously the pension reserves weren’t singled out in the formula. Instead, the bottom line was just the average total super balance values of all the interests in the fund. In practical terms, that meant any member in a fund with someone who had a defined benefit pension ended up with a disproportionate share of the fund’s overall earnings.

The new version will help those clients.

But the people it doesn’t help are those in funds with other reserves. Think of a case like this:

Deb and Shane have an SMSF in which they each have an average balance of $4m. The fund also has an average of $1m in reserves. The reserves are not pension reserves in this case. The actuarial calculation for this fund would see 50% of all Division 296 earnings allocated to Deb:

The other 50% will be allocated to Shane.

But that means even the earnings on the reserves will be shared between Deb and Shane.

If, instead, the reserves had been pension reserves, Deb and Shane would only have 4/9ths of the overall earnings allocated to each of them.

The Government has fixed the problem for the majority of cases – most reserves these days are pension reserves. But it hasn’t fixed the problem for:

• investment reserves, or
• reserves that used to be pension reserves but have now lost that status.

All in all, the final Division 296 regulations provide a lot of the certainty we need given the tax starts next week. But they leave some of the complexity and uncertainty I was hoping would be over by now.

Heffron's Super Companion includes comprehensive coverage of Division 296 tax including client guides, extensive FAQs and more. Learn more here.