Head of Education & Content
So your client has decided to wind up their SMSF? It’s vital for all involved to be aware of the potential traps in the windup process to avoid unnecessary costs and complexity.
The process of winding up an SMSF generally involves:
- checking the fund’s governing rules to make sure there are no special requirements,
- determining how the members’ benefits are to be dealt with (eg rolled over to other funds, or where permitted, cashed out of the superannuation system),
- organising for the fund’s assets to be sold (either on market, or to the members or a new fund in-specie),
- paying final fund expenses,
- rolling over or paying out the members’ benefits,
- preparing the fund’s final financial statements and SMSF Annual Return,
- having the fund audited for the year of wind up,
- lodging the final SMSF Annual Return and paying any outstanding tax, and
- closing the fund bank account.
However, there can be a number of potential traps in that process.
Lodge contribution notices before paying benefits
If a member has made personal contributions to the fund for which a tax deduction is to be claimed, a section 290-170 notice must be given to the fund and acknowledged by the trustee before the benefits are paid/rolled out.
Pensions must be paid “up to date” before they are commuted
For members drawing pensions, pension payments must be paid “up to date” first. Where pensions are to be fully commuted (ie the entire balance drawn as a lump sum), a pro-rata payment of the final year’s minimum must be made prior to the commutation. For partial commutations (ie a balance will remain in the pension account after the commutation), a pro-rata payment is not needed beforehand provided there will be sufficient balance remaining after the commutation for the minimum pension payment to be drawn.
Note, amounts commuted from a retirement phase pension (partially or fully) and withdrawn as a lump sum/rolled over to another fund do not count towards the minimum pension requirements. This is the case regardless of whether the commutation is made in cash or as an in-specie transfer of assets.
Disposal of assets will be a CGT event
Even in the current market, many SMSFs are sitting on substantial unrealised gains. In order to wind up an SMSF, the assets of the fund will need to be sold. It does not matter how this achieved (ie whether the assets are sold on market or transferred in-specie to the members or another fund), it will trigger a CGT event. The tax impact of this CGT event will depend on whether or not the fund is paying retirement phase pensions and whether there are any carried forward capital losses.
Note, any losses (revenue or capital) which are not utilised in the wind up process will be lost on wind up of the fund.
In-specie transfer of assets
If assets are to be transferred to the member in-specie, the trustee needs to ensure the transfer is transacted at market value with that value able to be substantiated by external evidence. Where the assets in question are collectables, the trustee will need to obtain a formal independent valuation of the asset before making the transfer.
In addition to the in-specie transfer being treated as sale for CGT purposes, in some jurisdictions stamp duty may also be payable.
If multiple assets are to be transferred out of the fund in-specie, ensuring the transactions happen on the same day will minimise the paperwork required.
Pension commutations & exempt income
Where an SMSF paying retirement phase pensions is to be wound up, there are some circumstances where it is preferable to only partially commute the pension, rollover (or pay out) the majority of the account and ensure the last payment is a pension payment. Why?
When an SMSF is to be wound up with all pensions being fully commuted and either paid out as a lump sum or rolled over to another fund, the commutation happens first.
As a full commutation causes the pension to end, if the fund had been entirely providing retirement phase pensions, the fund will no longer be in pension phase when the lump sum payment/rollover takes place.
If the lump sum payment/rollover is to be made by way of in-specie asset transfer, the disposal of the assets for CGT purposes will occur when the fund is no longer providing retirement phase pensions. If the fund was allowed to operate on a segregated basis, this segregation will end as soon as the pensions are fully commuted and hence the asset is no longer a segregated pension asset at the time disposal occurs. Rather it will occur in a distinct and separate accounting period and will be fully taxable.
However, if instead the retirement phase pension was only partially commuted, the pension would remain in place and the assets would remain segregated pension assets. This means that any income generated after the partial commutation would remain completely exempt from tax (in fact any realised capital gains from the in-specie asset transfers would be disregarded).
This issue does not arise for funds which are prohibited from operating on a segregated basis.
This is because funds that are not allowed to segregate always have their exempt investment income determined on the basis of an actuarial certificate which looks at the average pension balance over the full year compared to the average value of the fund (and so would be very close to 100% for a fund entirely in retirement pension phase until a full commutation).
This issue for full commutations and segregated funds is specifically a problem if the proceeds of the commutation are being transferred in-specie. If the assets are instead being sold (and cash is being transferred to the member or new fund), the trustee can simply elect to do so before the full commutation formally takes place.
Rather than tax being payable on lodgement of the fund’s final return, many SMSFs are due a tax refund for their final year of operation because their franking credits exceed the fund’s normal tax payable. It is not always necessary for this refund to be received before the fund can be wound up, provided it can be reliably calculated.
If the amount of the refund can be reliably calculated, the fund accountant would usually accrue into the fund’s final year accounts both the tax refund amount and how that amount will eventually be paid as a member benefit (eg lump sum, pension payment, rollover to another fund).
When the refund is received (after lodgement of the final return), the refund amount should then be immediately transferred out of the fund and the fund bank account closed.
However, if the refund amount cannot be reliably calculated (eg because the fund held investments in managed funds in the final year and the managed fund is unable to provide a reliable estimate of the amount of any franking credits, tax free/tax deferred amounts etc), then the fund will need to continue past 30 June. The alternative would be to treat the distributions as fully taxable and not claim any credits, which may be appropriate if the estimated refund would be less than the costs of running the fund into next financial year.
If the SMSF was paying retirement phase pensions and these pensions have been commuted (fully or partially), don’t forget the trustee will need to lodge a Transfer Balance Account Report (TBAR) with the ATO to report the commutations (and generate a debit/reduction in the pensioner’s Transfer Balance Account). This is the case regardless of whether the commutation was paid in cash or rolled over to another fund, but prompt lodgement will be critical if the monies are rolled over and new retirement phase pensions commenced in the rollover fund (as the new pensions will trigger a credit/addition to the pensioner’s Transfer Balance Account).
ATO assistance to wind up
Sometimes it may not be feasible for an SMSF to follow the “normal” wind up process. For example, a significant investment of the fund may have failed. Where returns are due but there are insufficient fund assets to pay accounting/audit fees, trustees often end up in an impossible position – unable to pay for the assistance they require to lodge outstanding returns and wind up the fund. Where compliance problems are also involved (eg benefits may have been taken illegally), the issues are further compounded. Trustees in this position should consider approaching the ATO for assistance in managing the wind up process.
No assets ever held
An SMSF is not legally established until the fund has assets set aside for the benefit of members. If no assets have ever been held by the fund, even if the structure will not be needed in the future, a wind up is not required as the fund has never formally existed. If an SMSF does not have, and has never had, assets set aside for the benefit of members and will not be used in the future but has an ABN, cancellation of the fund’s ABN is all that is required.
Once a fund has been established (ie has assets set aside for the benefit of members) and then wound up, it cannot be reactivated. If the former members/trustees wish to once again have an SMSF, a new fund will need to be set up.